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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-6247
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ARABIAN SHIELD DEVELOPMENT COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 75-1256622
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10830 NORTH CENTRAL EXPRESSWAY
SUITE 175
DALLAS, TEXAS 75231
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 692-7872
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
(TITLE OF CLASS)
Common Stock, par value $0.10 per share
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Indicate by check mark whether the registrant (l) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Number of shares of registrant's Common Stock, par value $0.10 per share,
outstanding as of March 15, 1999: 21,969,494.
The aggregate market value on March 15, 1999 of the registrant's voting
securities held by non-affiliates was $15,549,805.
DOCUMENTS INCORPORATED BY REFERENCE
(a) Selected portions of the registrant's definitive Proxy Statement for
the Annual Meeting to be held May 14, 1999. -- Part III
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PART I
ITEM 1. BUSINESS.
GENERAL
Arabian Shield Development Company (the "Company") was organized as a
Delaware corporation in 1967. The Company's principal business activities
include refining various specialty petrochemical products and developing mineral
properties in Saudi Arabia and the United States. All of its mineral properties
are presently undeveloped and require significant capital expenditures before
beginning any commercial operations. The Company's undeveloped mineral interests
are primarily located in Saudi Arabia.
United States Activities. The Company's domestic activities are primarily
conducted through a wholly owned subsidiary, American Shield Refining Company
(the "Refining Company"), which owns all of the capital stock of Texas Oil and
Chemical Co. II, Inc. ("TOCCO"). TOCCO owns all of the capital stock of South
Hampton Refining Company ("South Hampton"), and South Hampton owns all of the
capital stock of Gulf State Pipe Line Company, Inc. ("Gulf State"). South
Hampton owns and operates a specialty petrochemical products refinery near
Silsbee, Texas that is one of the largest manufacturers of pentanes consumed
domestically. Gulf State owns and operates three pipelines which connect the
South Hampton refinery to a natural gas line, to South Hampton's truck and rail
loading terminal and to a marine terminal owned by an unaffiliated third party.
The Company also directly owns all of American Shield Coal Company (the "Coal
Company") and approximately 51% of the capital stock of a Nevada mining company,
Pioche-Ely Valley Mines, Inc. ("Pioche"). Neither the Coal Company nor Pioche
conduct any substantial business activities. See Item 2. Properties.
Saudi Arabian Activities. The Company holds a mining lease covering an
approximate 44 square kilometer area in the Al Masane area in southwestern Saudi
Arabia. The Company was granted exploration licenses for the other areas in
southwestern Saudi Arabia which have expired.
On August 23, 1998, The Arabian Shield Company for Mining Industries Ltd.,
a Saudi limited liability company ("Arabian Mining"), was officially registered
with the Saudi Ministry of Commerce and issued a registration certificate.
Arabian Mining is now officially licensed to conduct business in Saudi Arabia
and is authorized to mine and process zinc and copper concentrates and
silver-gold dore from the Al Masane lease area. The Company plans to enter into
a joint venture agreement regarding Arabian Mining with Al Mashreq Company for
Mining Investments ("Al Mashreq"), a Saudi limited liability company owned by
Saudi Arabian investors (including certain of the Company's shareholders). Terms
of the proposed joint venture agreement contemplate that Arabian Mining will be
equally owned and managed by the two proposed partners. The Company and Arabian
Mining have applied to the Saudi Ministry of Petroleum and Mineral Resources
requesting the transfer of the Company's Al Masane mining lease to Arabian
Mining.
In 1996, an independent mining consulting firm estimated the total capital
costs of the Al Masane mining project to be $88.6 million. The Company and Al
Mashreq are diligently pursuing the financing of the project so that commercial
production can begin as contemplated in a recently updated feasibility study.
There can be no assurance that adequate capital for the project will be obtained
in order for contemplated commercial production to begin. The ultimate recovery
of all of the Company's mineral exploration and development costs cannot be
determined at this time.
See Item 2. Properties for additional discussions regarding all of the
Company's properties, the proposed joint venture and financing of the Al Masane
project.
Note 12 to the Company's Consolidated Financial Statements contains
information regarding the Company's industry segments for the years ended
December 31, 1998, 1997 and 1996. In addition, see Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations for a
discussion of the Company's liquidity, capital resources and operating results.
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FOREIGN OPERATIONS
Since a substantial portion of the Company's mineral properties and related
interests are located outside of the United States, its business and properties
are subject to foreign laws and foreign conditions, with the attendant varying
risks and advantages. Foreign exchange controls, foreign legal and political
concepts, foreign government instability, international economics and other
factors create risks not necessarily comparable with those involved in doing
business in the United States.
COMPETITION
The Company competes in both the petrochemical and mining industries.
Accordingly, the Company is subject to intense competition among a large number
of companies, both larger and smaller than the Company, many of which have
financial and other resources (including facilities and personnel) greater than
the Company. In the specialty products and solvents markets, the Refining
Company has one principal competitor. Generally good economic conditions have
meant strong demand for its specialty products and solvents. Consequently, the
Refining Company has not faced any recent significant price competition in these
markets. Almost all of the Refining Company's raw materials are purchased on the
open market. The cost of these materials is a function of spot market oil and
gas prices, which during most of 1998, trended down.
ENVIRONMENTAL MATTERS
In 1993, while remediating a small spill area, The Texas Natural Resources
Conservation Commission ("TNRCC") requested South Hampton to drill a well to
check for groundwater contamination under the spill area. Two pools of
hydrocarbons were discovered to be floating on the groundwater at a depth of
approximately 25 feet. One pool is under the site of a former gas processing
plant owned and operated by Sinclair, Arco and others before its purchase by
South Hampton in 1981. The other pool is under the South Hampton facility.
Subsequent tests determined that hydrocarbons are contained on the property and
are not moving in any direction. The recovery process was initiated in June 1998
and approximately $53,000 was spent setting up the system. The recovery is
proceeding as planned and is expected to continue for several years until the
pools are reduced to an acceptable level. Expenses of recovery and periodic
migration testing will be recorded as normal operating expenses. Expenses for
future years recovery are expected to stabilize and be less per annum than the
initial set up cost, although there can be no assurance of this effect.
Consulting engineers estimate that as much as 20,000 barrels of recoverable
material may be available to South Hampton for use in its refining process, but
no reduction has been made in the accrual for remediation costs due to the
uncertainties relating to the recovery process. Also, see Item 3. Legal
Proceedings.
The Clean Air Act Amendments of 1990 have had a positive effect on the
Refining Company's business as plastics manufacturers are searching for ways to
use more environmentally acceptable solvents in their processes. Plastics
manufacturers have historically used C6 hydrocarbons (hexanes) as coolants and
catalyst carrying agents. There is a current trend among plastics manufacturers
toward the use of lighter and more recoverable C5 hydrocarbons (pentanes) which
are a large part of the Refining Company's product line. Management believes its
ability to manufacture high quality solvents in the C5 hydrocarbon market will
provide a basis for growth over the next few years; however, there can be no
assurance that such growth will occur. While the refinery continues to
manufacture C6 solvents, its manufacturing of these solvents is being phased
out. The Aromax(R) unit, which was jointly developed with Chevron Research
Company, has the ability to convert C6 hydrocarbons into benzene and other more
valuable aromatic compounds, which one of the reasons the Refining Company
initially participated in the Aromax(R) development project. Also, see Item 2.
Properties.
PERSONNEL
The Company's officers who are resident in the United States are Mr. John
A. Crichton, Chairman of the Board, Mr. Jonathan Cocks, Vice President, and Mr.
Drew Wilson, Jr., Secretary and Treasurer. Mr. Hatem El-Khalidi, the Company's
President and Chief Executive Officer, supervises the Company's 28 employees in
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Saudi Arabia, consisting of the office personnel and field crews who conduct
exploration and related activities. The Refining Company employs 55 persons.
ITEM 2. PROPERTIES.
SPECIALTY PRODUCTS REFINERY
The Company's primary source of revenues is the specialty products refinery
owned and operated by South Hampton near Silsbee, Texas. The refinery presently
consists of seven operating units that, while interconnected, make distinct
products through differing processes: (i) a pentane-hexane unit; (ii) a
catalytic reformer; (iii) an aromatics fractionation unit; (iv) a cyclopentane
unit; (v) an Aromax(R) unit; (vi) an aromatics hydrogenation unit; and (vii) a
specialty fractionation unit. All of these units are currently in operation. A
solvent fractionation unit is under construction and scheduled to start
production on April 1, 1999.
The pentane-hexane unit's design capacity is approximately 2,200 barrels
per day ("BPD") of feedstock. While the unit averaged 1,975 barrels per stream
day during 1998, during four different months it set production records by
processing at 108% of design capacity. The unit consists of a series of
fractionation towers and hydrotreaters capable of producing high purity solvents
that are sold primarily to expandable polystyrene and high density polyethylene
producers. South Hampton purchases most of its feedstock for this unit on the
spot market.
The catalytic reforming unit is a standard industry design using a
platinum-rhenium catalyst that produces an aromatics concentrate that is used as
feedstock for an aromatics extraction unit, as well as hydrogen that is utilized
in other processes. The design capacity of the reformer is 4,000 BPD. The unit
is operated as a source of hydrogen for the pentane-hexane unit and operates in
tandem with the Aromax(R) unit as feedstock balances dictate. The unit's average
production was 425 barrels per stream day in 1998.
The aromatics fractionation unit consists of two towers with a design
capacity of 750 BPD. The unit processes an aromatic feedstock stream into three
specialized aromatic solvents used in various applications such as pesticides,
paints and coatings and adhesives. This unit is leased to a customer for its own
use pursuant to a toll processing contract that provides for the payment of a
minimum daily charge.
The cyclopentane unit consists of three specialized fractionation towers
designed to produce a consistently high quality product that is used in the
expandable polystyrene industry. The design capacity of the cyclopentane unit is
400 BPD. The unit operates from feedstock supplied by the pentane-hexane unit
and averaged 215 barrels of production per stream day during 1998.
The Aromax(R) unit is the world's first commercial unit using Chevron
Research Company's proprietary process to produce a high benzene content product
that is sold as feedstock to refiners operating benzene extraction units. This
process converts petroleum naphtha into liquid hydrocarbons having a high
aromatic hydrocarbon content. The Aromax(R) unit's design capacity is 400 BPD
and uses as feedstock a by-product from the South Hampton's pentane-hexane unit
as well as from outside hydrotreaters. The unit's average production throughput
during 1998 was 145 barrels per stream day. Chevron Research Company has agreed
to continue development of the Aromax(R) process and the unit continues to
successfully operate as designed.
The aromatics hydrogenation unit consists of a hydrotreating reactor and a
single fractionation tower that strips excess gas from the product. The design
capacity of this unit is 500 BPD. It converts a high purity aromatic feedstock
into a more environmentally acceptable high purity solvent. This unit is leased
to a customer for its own use pursuant to a toll processing contract that
provides for the payment of a minimum daily charge.
The specialty fractionation unit consists of a single fractionation tower
and has a design capacity of 500 BPD. This unit is leased to a customer for its
own use pursuant to a toll processing contract that provides for the payment of
a minimum daily charge.
The specialty solvents unit that is under construction consists of three
fractionation towers, one of which operates under vacuum. When completed, this
unit will process a specialized high purity feedstock and
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produce four high purity solvents. This unit is to be leased to a customer for
its own use pursuant to a toll processing contract that provides for the payment
of a minimum daily charge.
South Hampton owns approximately 87 storage tanks with a total capacity of
approximately 285,000 barrels. Two spherical storage tanks with a total capacity
of 10,000 barrels each are under construction and expected to be completed by
May 1, 1999. These tanks will be utilized in the management of pentane
inventory. The refinery is situated on 100 acres of land, approximately 70 acres
of which are developed. South Hampton also owns a truck and railroad loading
terminal that consists of eight storage tanks, a rail spur and truck and tank
car loading facilities.
As a result of the 1990 production capacity expansion and the toll
processing contracts, essentially all of South Hampton's standing equipment is
operational. It also owns certain surplus equipment, which is stored on site
that could be used to assemble additional processing units, such as a
hydrocracking unit with a 2,000 BPD capacity. South Hampton periodically
reviews, as market and competitive conditions warrant, the feasibility of
expanding the capacity of its existing pentane-hexane unit or constructing
additional facilities.
Gulf State owns and operates three 8 inch pipelines aggregating
approximately 50 miles in length that connect South Hampton's refinery to a
natural gas line, to South Hampton's truck and rail loading terminal and to a
marine terminal owned by an unaffiliated third party. South Hampton leases
storage facilities at the marine terminal.
SAUDI ARABIA MINING PROPERTIES
Al Masane Project
The Al Masane project, consisting of an area of approximately 44 square
kilometers, contains extensive ancient mineral workings and smelters. From
ancient inscriptions in the area, it is believed that mining activities went on
sporadically from 1000 BC to 700 AD. The ancients are believed to have extracted
mainly gold, silver and copper.
Initial Exploration Work and Prior Feasibility Studies. The Saudi Arabian
government granted the Company exploration licenses for the Al Masane and Wadi
Qatan areas in 1971. Subsequently, the Company conducted substantial geological
and geophysical activities in these areas. Core drilling and studies by
independent consulting firms concluded that Al Masane's copper, zinc, gold and
silver prospects could be put in production sooner than the nickel prospect at
Wadi Qatan. Metallurgical tests also showed difficulty in separating the nickel
at Wadi Qatan. During 1977, a pre-feasibility mining study was conducted at Al
Masane by the mining consulting firm of Watts, Griffis and McOuat Limited of
Toronto, Canada ("WGM"). WGM recommended an extensive development program for
the Al Masane prospect.
Phase I of WGM's recommended Al Masane development program was completed in
April 1981. It involved construction of underground tunnels parallel to the ore
bodies from which extensive underground core drilling was done in order to prove
the quantity and quality of the ore reserves. This work was financed primarily
with an $11 million interest-free loan from the Saudi Arabian Ministry of
Finance. As a result of this work, WGM concluded that sufficient ore reserves
had been established to justify completion of a full bank feasibility study to
determine the economic potential of establishing a commercial mining and ore
treatment operation at Al Masane. WGM and SNC/GECO of Montreal, Canada conducted
this study in 1982. They concluded that the Al Masane deposits would support
commercial production of copper, zinc, gold and silver and recommended
implementation of Phase II of the Al Masane development program, which would
involve the construction of mining, ore treatment and support facilities. WGM's
September 1984 reevaluation of the project resulted in no substantial changes of
their initial conclusions and recommendations.
The Company continued its exploration work at Al Masane after 1984.
Consequently, WGM upwardly revised its reserve estimates in 1989 and again
concluded that a proposed mining operation was economically viable as well as
having high potential for the discovery of additional ore zones.
Current Feasibility Studies. The Saudi government granted the Company a
mining lease for the Al Masane area on May 22, 1993. The Company subsequently
commissioned WGM to prepare a new fully
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bankable feasibility study to be used to obtain financing for commercial
development of the project. The study, which was completed in 1994, contained
specific recommendations to insure that project construction was accomplished
expeditiously and economically. The engineering design and costing portions of
the study were performed by Davy International of Toronto, Canada ("Davy"). WGM
and Davy updated this study in 1996. A summary of the studies' findings are as
follows:
The Al Masane ore is located in three mineralized zones known as Saadah, Al
Houra and Moyeath. The following table sets forth a summary of the diluted
minable, proven and probable ore reserves at the Al Masane project, along with
the estimated average grades of these reserves:
RESERVE COPPER ZINC GOLD SILVER
ZONE (TONNES) (%) (%) (G/T) (G/T)
- ---- --------- ------ ---- ----- ------
Saadah...................................... 3,872,400 1.67 4.73 1.00 28.36
Al Houra.................................... 2,465,230 1.22 4.95 1.46 50.06
Moyeath..................................... 874,370 0.88 8.92 1.29 64.85
--------- ---- ---- ---- -----
Total............................. 7,212,000 1.42 5.31 1.19 40.20
For purposes of calculating, proven and probable reserves, a dilution of 5%
at zero grade on the Saadah zone and 15% at zero grade on the Al Houra and
Moyeath zones was assumed. A mining recovery of 80% has been used for the Saadah
zone and 88% for the Al Houra and Moyeath zones. Mining dilution is the amount
of wallrack adjacent to the ore body that is included in the ore extraction
process.
Proven reserves are those mineral deposits for which quantity is computed
from dimensions revealed in outcrops, trenches, workings or drillholes, and
grade is computed from results of detailed sampling. For ore deposits to be
proven, the sites for inspection, sampling and measurement must be spaced so
closely and the geologic character must be so well defined that the size, shape,
depth and mineral content of reserves are well established. Probable reserves
are those for which quantity and grade are computed from information similar to
that used for proven reserves, but the sites for inspection, sampling and
measurement are farther apart or are otherwise less adequately spaced. However,
the degree of assurance, although lower than that for proven reserves, must be
high enough to assume continuity between points of observation.
The metallurgical studies conducted on the ore samples taken from the zones
indicated that 87.7% of the copper and 82.6% of the zinc could be recovered in
copper and zinc concentrates. Overall, gold and silver recovery from the ore was
estimated to be 77.3% and 81.3%, respectively, partly into copper concentrate
and partly as bullion through cyanide processing of zinc concentrates and mine
tailings.
A test program to evaluate the economies of the cyanidation of the zinc
concentrate and tailings in order to improve gold and silver recoveries found
gold and silver recoveries to range from 50% to 77%. To recover gold and silver
from the zinc concentrate and tailings, WGM recommended that a cyanidation plant
be included in the process flowsheet. Dore bullion would be produced. WGM
concluded that the inclusion of a cyanidation plant would make a positive
contribution to the economies of the project under the base conditions.
The mining and milling operation recommended by WGM for Al Masane would
involve the production of 2,000 tonnes of ore per day (700,000 tonnes per year),
with a mine life of over ten years. Annual production is estimated to be 34,900
tonnes of copper concentrate (25% copper per tonne) containing precious metal
and 58,000 tonnes of zinc concentrate (54% zinc per tonne). Total output per
year of gold and silver is estimated to be 22,000 ounces of gold and 800,000
ounces of silver from the copper concentrate and bullion produced. The
construction of mining, milling and infrastructure facilities is estimated to
take 21 months to complete. Construction necessary to bring the Al Masane
project into production includes the construction of a 2,000 tonne per day
concentrator, infrastructure with a 300 man housing facility and the
installation of a cyanidation plant to increase the recovery of precious metals
from the deposit. Project power requirements will be met by diesel generated
power.
WGM recommended that the Al Masane reserves be mined by underground methods
using trackless mining equipment. Once the raw ore is mined, it would be
subjected to a grinding and treating process
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resulting in three products to be delivered to smelters for further refining.
These products are zinc concentrate, copper concentrate and dore bullion. The
copper and zinc concentrates also contain valuable amounts of gold and silver.
These concentrates and the dore bullion to be produced from the cynidization
plant are estimated to be 22,000 ounces of gold and 800,000 ounces of silver and
will be sold to copper and zinc custom smelters and refineries worldwide. After
the smelter refining process, the metals could be sold by the Company or the
smelter for the Company's account in the open market.
In the feasibility study, WGM states that there is potential to find more
reserves within the lease area, as the ore zones are all open at depth. Further
diamond drilling, which will be undertaken by the Company, is required to
quantify the additional mineralization associated with these zones. A
significant feature of the Al Masane ore zones is that they tend to have a much
greater vertical plunge than strike length; relatively small surface exposures
such as the Moyeath zone are being developed into sizeable ore tonnages by
thorough and systematic exploration. Similarly, systematic prospecting of the
small gossans in the area could yield significant tonnages of new ore.
The 1996 update shows the estimated capital cost to bring the project into
operation to be $88.6 million. At a production rate of 700,000 tonnes per year,
the operating cost of the project (excluding concentrate freight, ship loading,
smelter charges, depreciation, interest and taxes) was estimated to be $38.49
per tonne of ore milled.
WGM prepared an economic analysis of the project utilizing cash flow
projections. A base case was prepared that included those project elements which
are most likely to be achieved. WGM believed that a majority of the base case
assumptions used in the 1994 feasibility study remained valid, including the ore
reserves, mill feed grade, production rate, metal recoveries and concentrate
grade and smelter returns. Metal prices, capital costs, operating costs and the
corporate structure were adjusted to reflect more current information. Capital
and operating costs were adjusted in conformity with the updated estimates
prepared by Davy.
The base case assumes the corporate structure of the entity to be formed to
operate the project, planned to be Arabian Mining, will be owned 50% by the
Company and 50% by Saudi Arabian investors and that the owners of this entity
would contribute an aggregate of $21.2 million to the cost of the project. The
base case further assumes financing for the project from commercial loans in the
aggregate amount of $21.2 million bearing interest at the rate of 8% per year
and a loan in the amount of $43.8 million from the Saudi Industrial Development
Fund ("SIDF") repayable in equal annual installments over the initial life of
the mine. Cash generated by the operation of the project would contribute the
remainder of the project financing. The base case assumes that the $11 million
loan outstanding to the Saudi Arabian government will be paid by the Company in
accordance with a repayment schedule to be agreed upon with the Saudi Arabian
government from the Company's share of the project's cash flows. Based on these
assumptions, and assuming the average prices of metal over the life of the mine
to be $1.05 per pound for copper, $.60 per pound for zinc, $400 per ounce of
gold and $6.00 per ounce of silver, WGM's economic analysis of the base case
shows the project will realize an internal rate of return of 13.1%, the
Company's and the Saudi Arabian investors' internal rates of return would be
27.3% and 12.1%, respectively, and projected net cash flow (after debt
repayment) from the project of $95.1 million. The 1994 feasibility study base
case showed the project would realize a 14.05% internal rate of return. Cash
flow under the base case is exclusive of income tax as the base case assumes
that any such tax would be paid by individual investors and not by the project.
Assuming a 10% discount rate, the net present value of the project as shown in
the update is $12.16 million compared to the $15.5 million net present value of
the project shown in the 1994 feasibility study. Based on the update, WGM
believes that the economic analysis shows that the project remains viable.
Mining Lease. As the holder of the Al Masane mining lease, the Company is
solely responsible to the Saudi Arabian government for the rental payments and
other obligations provided for by the mining lease and repayment of the
previously discussed $11 million loan. The Company's interpretation of the
mining lease is that repayment of this loan will be made in accordance with a
repayment schedule to be agreed upon with the Saudi Arabian government from the
Company's share of the project's cash flows. The initial term of the lease is
for a period of thirty (30) years from May 22, 1993, with the Company having the
option to renew or extend
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the term of the lease for additional periods not to exceed twenty (20) years.
Under the lease, the Company is obligated to pay advance surface rental in the
amount of 10,000 Saudi Riyals (approximately $2,667 at the current exchange
rate) per square kilometer per year (approximately $117,300 annually) during the
period of the lease. It is contemplated that responsibility for the payment of
all future rental payments would be assumed by Arabian Mining when title to the
Al Masane mining lease is transferred to it. In addition, the Company must pay
income tax in accordance with the income tax laws of Saudi Arabia then in force
and pay all infrastructure costs. The Saudi Arabian Mining Code provides that
income tax will not be due during the first stage of mining operations, which is
the period of five years starting from the earlier of (i) the date of the first
sale of products or (ii) the beginning of the fourth year since the issue of the
mining lease. The lease gives the Saudi Arabian government priority to purchase
any gold production from the project as well as the right to purchase up to 10%
of the annual production of other minerals on the same terms and conditions then
available to other similar buyers and at current prices then prevailing in the
free market. Furthermore, the lease contains provisions requiring that
preferences be given to Saudi Arabian suppliers and contractors, that the
Company employ Saudi Arabian citizens and provide training to Saudi Arabian
personnel.
Reference is made to the map on page 10 of this Report for information
concerning the location of the Al Masane project.
Project Financing and Proposed Joint Venture. As detailed above, the
estimated total capital cost to bring the Al Masane project into production is
$88.6 million. The Company does not presently have sufficient funds to bring
this project into production. Also, see Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations for a further
discussion of these matters.
In order to commercially develop the Al Masane project, the Company plans
to enter into the Arabian Mining joint venture with Al Mashreq. The following
summarizes certain proposed terms and conditions of the planned joint venture.
The Company anticipates that, once established, Arabian Mining would attempt to
finance the project and would be responsible for the construction and operation
of the mining facilities. In the event the Arabian Mining joint venture is
established, the Company would be obligated to transfer title to the mining
lease as well as its beneficial interest in the Al Masane project to the planned
joint venture. It is also possible that the Company would be required to
transfer its other Saudi mining interests, if any, to the planned joint venture.
In the event Arabian Mining is unable to obtain acceptable financing for the
project by a date to be agreed upon, then either joint venture partner may
terminate the joint venture agreement. In this event, full title to the mining
lease and other interests, if any, that the Company transferred to Arabian
Mining would revert back to the Company. If the joint venture is terminated, the
Company may be liable to Al Mashreq for any prior surface rentals and other such
costs which either Al Mashreq or the planned joint venture paid. At December 31,
1998 the amount of these costs paid by Al Mashreq was $469,333.
Pursuant to the mining lease agreement, when the Al Masane project is
profitable the Company is obligated to form a Saudi public stock company with
the Petroleum Mineral Organization ("Petromin"). Petromin is the Saudi Arabian
government's official mining and petroleum company. In 1994, the Company
received instructions from the Saudi Ministry of Petroleum and Mineral Resources
stating that it is possible for the Company to form a Saudi company without
Petromin, but the sale of stock to the Saudi public could not occur until the
mine's commercial operations were profitable for at least two years. The
instructions added that Petromin still had the right to purchase shares in the
Saudi public stock company any time it desires. The joint venture partners
contemplate Arabian Mining would be transformed into a Saudi public stock
company sometime after it has been profitable for two years. At that time, the
Company and Al Mashreq would own no less than 50% of the shares of the
contemplated Saudi public stock company, Petromin would have an option to
acquire up to 25% of the shares and the remaining shares would be offered for
sale in Saudi Arabia pursuant to a public stock subscription offering. Title to
the mining lease and the other obligations specified in the mining lease would
be transferred to the Saudi public stock company. However, the Company would
remain responsible for the repaying the $11 million loan to the Saudi Arabian
government.
On behalf of the planned joint venture, the Company and Al Mashreq applied
to the Saudi Industrial Development Fund (the "SIDF") for a loan of
approximately $38.1 million in 1995. The SIDF makes interest-free loans to
industrial projects in Saudi Arabia and charges a 2.5% service fee. Conditional
loan
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approval was granted in December 1997. The conditions that must be met prior to
receiving unconditional loan approval from the SIDF include, but are not limited
to, (i) transfer of the Al Masane mining lease (free and clear of all liens) to
the proposed joint venture, (ii) receipt by the SIDF of acceptable loan
guarantees from each of the two proposed joint venture partners and (iii)
receipt by the SIDF of an acceptable agreement between the Company and the Saudi
Ministry of Finance regarding the Company's repayment of the previously
discussed $11.0 million loan.
Given that open market prices for the minerals to be produced by the Al
Masane project are presently at or near their recent historical lows, there can
be no assurances that the Company or the planned joint venture will be able to
obtain financing from the SIDF or any other sources. In addition, there can be
no assurances that the Company will be able to negotiate an acceptable joint
venture and/or other agreement(s) with Al Mashreq. In either event, the Company
would attempt to maintain the Al Masane mining lease and continue with a modest
exploration and reserve development program in order to expand Al Masane's
mineral reserve base and improve the existing metallurgical recovery rate, which
is presently estimated at 82% zinc and 87% copper. Once open market prices for
the minerals to be produced by the mine sufficiently improve, the Company would
then again attempt to obtain acceptable financing to commercially develop the Al
Masane mining project.
Other Exploration Areas in Saudi Arabia
During the course of its exploration and development work in the Al Masane
area, the Company has carried on exploration work in other areas in Saudi Arabia
and plans to apply for an additional exploration license(s) for these areas.
With respect to these other areas, the Company has an agreement with Petromin
that governs the rights of the parties if the exploration licenses granted to
the Company or Arabian Mining are converted into a mining lease. Under this
agreement, Petromin is granted an option to acquire, at any time, a 25% interest
in any mineral mining project in Saudi Arabia that is the subject of the
exploration licenses.
In 1971, the Saudi Arabian government awarded the Company exclusive mineral
exploration licenses to explore and develop the Wadi Qatan area in southwestern
Saudi Arabia. The Company was subsequently awarded an additional license in 1977
for an area north of Wadi Qatan at Jebel Harr. While these licenses have
expired, the Company has received verbal assurance from Saudi Arabian government
officials that the licenses will be extended as long as exploratory work is
being carried out on the areas that they covered. However, no formal extensions
from the government have been obtained.
The Company applied for an exploration license covering an area surrounding
the Al Masane mining lease area, which is referred to as the Greater Al Masane
area. Although a license has not been formally granted for the Greater Al Masane
area, the Company has been authorized in writing by the Saudi Arabian government
to carry out exploration work on the area. Exploration work has been carried on
and paid for by the Company.
Once financing for the Al Masane project is obtained, either the Company or
Arabian Mining plan to formally apply for an expanded exploration license for an
area of approximately 2,800 square kilometers which includes the original
Greater Al Masane area plus the Wadi Qatan and Jebel Harr areas. In the event
commercially exploitable minerals are found, then any exploration license(s)
granted by the government could be converted into mining leases upon application
to the Saudi Arabian Ministry of Petroleum and Mineral Resources.
Reference is made to the map on page 10 of this Report for information
concerning the location of the foregoing areas.
Wadi Qatan and Jebel Harr. The Wadi Qatan area is located in southwestern
Saudi Arabia. Jebel Harr is north of Wadi Qatan. Both areas are approximately 30
kilometers east of the Al Masane area. These areas consist of 40 square
kilometers, plus a northern extension of an additional 13 square kilometers. The
Company's geological, geophysical and limited core drilling disclosed the
existence of massive sulfides containing an average of 1.2% nickel. Reserves for
these areas have not yet been classified and additional exploration work is
required. After obtaining an exploration license for the Wadi Qatan and Jebel
Harr areas,
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the Company or Arabian Mining would continue its exploratory drilling program in
order to prove whether enough ore reserves exist to justify a viable mining
operation. While initial indications are encouraging, there is no assurance that
a viable mining operation could be established.
Greater Al Masane. The Company has filed an exploration license
application, which has been verbally approved, for an area of approximately
1,100 square kilometers around Al Masane, which is also referred to as Greater
Al Masane. This area includes an ancient gold mining prospect at Jubal Guyan,
about six miles east of the original Al Masane prospect and seven miles west of
Wadi Qatan. Although an exploration license has not been formally granted, the
Saudi Arabian government has given the Company written authorization to conduct
exploration work in the area. Core samples indicate an average grade of 7 grams
of gold per tonne. Additional sampling is being conducted at Jubal Guyan, and
after the results of the sampling are obtained, an evaluation will be made as to
any future drilling locations. Geological, geochemical and geophysical work on
the Greater Al Masane area has revealed mineralization similar to that
discovered at Al Masane.
As previously stated, the Company does not possess current formal
exploration licenses for any of the above areas. The absence of such licenses
creates uncertainty regarding the Company's rights and obligations, if any, in
these areas. The Company believes it has satisfied the Saudi Arabian
government's requirements in these areas and that the government should honor
the Company's claims.
U.S. MINERAL INTERESTS
The Company's mineral interests in the United States include its ownership
interests in the Coal Company and Pioche. The Coal Company sole remaining asset
is its net operating loss carryforward of approximately $5.9 million at December
31, 1998 and its future, if any, is uncertain. Pioche also has been inactive for
many years.
Nevada Mining Properties. Pioche's properties include 48 patented and 80
unpatented claims totaling approximately 3,500 acres. All the claims are located
in the Pioche Mining District, Lincoln County, Nevada. There are prospects and
mines on these claims that previously produced silver, gold, lead, zinc and
copper. The ore bodies are both oxidized and sulfide deposits, classified into
three groups: fissure veins in quartzite, mineralized granite porphyry and
replacement deposits in carbonate rocks (limestone and dolomites). An
Exploration Agreement and Option to Purchase between Pioche and a large mining
company was terminated during 1998. The mining company paid all annual taxes and
claim rentals during the agreement's term.
There is a 300-ton-a-day processing mill on property owned by Pioche. The
mill is not currently in use and a significant expenditure would be required in
order to put the mill into continuous operation.
OFFICES
The Company has a year-to-year lease on space in an office building in
Jeddah, Saudi Arabia, used for office occupancy. The Company also leases a house
in Jeddah that is used as a technical office and for staff housing. The Company
continues to lease office space in Dallas, Texas on a month-to-month basis. It
also owns a base camp and accompanying facilities and equipment at the Al Masane
project site.
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ITEM 3. LEGAL PROCEEDINGS.
South Hampton, together with over twenty-five other companies, was a
defendant in two lawsuits brought in different Jefferson County, Texas District
Courts. The suits were filed in July 1993 and 1994 by the same Beaumont, Texas
law firm on behalf of two former employees of the Goodyear Tire & Rubber Company
plant located in Beaumont, Texas. Each suit claimed illness and diseases
resulting from alleged exposure to chemicals, including benzene, butadiene
and/or isoprene, during their employment with Goodyear. Each plaintiff claimed
the defendant companies engaged in the business of manufacturing, selling and/or
distributing these chemicals in a manner which subjected each and all of them to
liability for unspecified actual and punitive damages. South Hampton entered
into settlement agreements with the two plaintiffs in March 1997 and January
1998, respectively, by agreeing to pay each plaintiff the amount of $25,000 in
full and final settlement of all claims by each such plaintiff against South
Hampton. Another similar lawsuit, filed by the same law firm on behalf of
another former Goodyear employee, was filed in a Jefferson County District Court
in December 1997 containing the same allegations and seeking unspecified actual
and punitive damages. South Hampton intends to vigorously defend itself against
this lawsuit.
In August 1997, the TNRCC's Executive Director filed a preliminary report
and petition with the TNRCC alleging that South Hampton violated various TNRCC
rules, TNRCC permits issued to South Hampton, a TNRCC order issued to South
Hampton, the Texas Water Code, the Texas Clean Air Act and the Texas Solid Waste
Disposal Act. The violations generally relate to the management of volatile
organic compounds in a manner that allegedly violates the TNRCC's air quality
rules and the storage, processing and disposal of hazardous waste in a manner
that allegedly violates the TNRCC's industrial and hazardous waste rules. The
TNRCC's Executive Director recommends the TNRCC enter an order assessing
administrative penalties against South Hampton in the amount of $709,408 and
order South Hampton to undertake such actions as are necessary to bring its
operations at its refinery and its bulk terminal into compliance with Texas
Water Code, the Texas Health and Safety Code, TNRCC rules, permits and orders.
South Hampton is, and intends to continue to, vigorously defending itself
against this proceeding. Appropriate modifications were made by South Hampton
where it appeared there were legitimate concerns. A preliminary hearing was held
in November 1997, but no further action has been taken.
In May 1991, the Company filed a complaint with the U.S. Department of
Justice ("DOJ") against Hunt Oil Company of Dallas, Texas ("Hunt"). The
Company's complaint alleged various violations of the Foreign Corrupt Practices
Act ("FCPA") by Hunt, at the Company's detriment, in obtaining its 1981
Petroleum Production Sharing Agreement ("PSA") in Yemen. The DOJ requested
additional documentation regarding the Company's allegations in 1995 that the
Company provided in early 1996. In late 1996, the DOJ advised the Company that
the documents presented did not provide sufficient evidence of any criminal
activity and that the DOJ did not intend to pursue the investigation. In
December 1996, after providing the DOJ with additional legal analyses, the
Company's representatives were told that the DOJ would take a more aggressive
stance if additional legal evidence was presented to the DOJ. In an effort to
comply with the DOJ's request, in 1997 the Company requested certain documents
from the Central Intelligence Agency ("CIA") under the Freedom of Information
Act ("FOIA"). The Company believes the requested documents may contain the
evidentiary information that the DOJ needs to properly and sufficiently evaluate
the Company's compliant against Hunt. The CIA refused to either confirm or deny
the existence of the requested information. After exhausting its administrative
appeals, the Company filed suit against the CIA in early 1998 in the U.S.
District Court for the Northern District of Texas seeking a judicial
determination of the Company's FOIA request. The Company argued the FOIA
specifically prohibits any agency from using the FOIA to conceal criminal
activity, in this instance Hunt's violation of the FCPA. Following a February
1999 hearing, the Court rejected the Company's arguments and issued a summary
judgement in favor of the United States and its agency, the CIA. The Company
believes the Court erred in its interruption of the FOIA and, since it believes
this could be a landmark case it has filed an appropriate appeal with the U.S.
Court of Appeals for the Fifth Circuit. In addition, the Company intends to
request additional documents from both the CIA and DOJ under appropriate
provisions of the FOIA and may seek judicial review in the event its requests
are denied. In the event the Company is able to provide the DOJ with appropriate
legal evidence and the DOJ
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prevails in any FCPA action against Hunt regarding the PSA, the Company would
then institute an appropriate action against Hunt in accordance with the
provisions of the Victim Restitution Act.
In late 1994, two prominent Yemen newspapers published articles that
accused Yemen Hunt Oil Company ("Yemen Hunt"), a wholly owned subsidiary of
Hunt, of obtaining its PSA by corrupting certain government officials in Yemen.
Specifically, each article alleged that Yemen Hunt engaged in corrupt practices
in order to exclude the Company's application from consideration for the PSA
that was subsequently awarded to Hunt and its subsidiary, Yemen Hunt. The
executive vice president of Yemen Hunt sent a letter to the editor of one of
these newspapers. This letter, which was published on December 7, 1994, stated,
after explicitly mentioning the Company and its then partner, Dorchester Gas
Company, that "(Yemen Hunt) knows well those suspicious companies who are mainly
engaged in political activities for the purpose of undermining the economic
interest of Yemen . . ." On December 26, 1995, the Company filed a criminal
libel complaint with Yemen's Attorney General for Publications in Sana'a, Yemen
against Yemen Hunt. Its complaint alleged that Yemen Hunt, in its published
letter, criminally libeled the Company, which if not addressed, could seriously
affect the Company's and its employees' business and reputation in the Middle
East. In October 1996, the Deputy Attorney General for Publications in Yemen
issued his official decision to the Company. This decision, which was released
after the Attorney General's office had taken statements from the Company's
president and the chief of Yemen Hunt's legal department, stated it was evident
that the above mentioned letter was libelous to the Company. However, Yemen Hunt
could not be prosecuted for criminal libel since the four-month statute of
limitations period for criminal libel had run. The Company had been vigorously
pursuing evidence regarding Hunt, the PSA and related matters in Yemen. However,
in 1997 the Company was strongly advised that it would be extremely dangerous
for any of its officers, representatives or consultants to go to Yemen and
pursue further evidence against Hunt. The Company plans to abide by that advice
for the foreseeable future.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
The Company's common stock trades on The NASDAQ Stock Market under the
symbol: ARSD. The following table sets forth the high and low closing sale
prices for each quarter of 1998 and 1997, respectively, as reported by NASDAQ.
1998 1997
----------------------- -----------------------
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
---- ---- --- --- --- --- ---- ----
High............................... 3 13/16 2 15/16 2 3/4 2 1/16 2 3/4 2 6 3/8 3 31/32
Low................................ 2 1/16 2 1 7/8 1 7/32 1 1/2 1 1 1 3/4
At March 15, 1999, there were 803 record holders of the Company's common
stock. The Company has not paid any dividends since its inception and, at this
time, does not have any plans to pay any dividends in the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA.
The following is a five-year summary of selected financial data of the
Company (in thousands, except per share amounts):
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
Revenues............................. $25,089 $26,174 $22,014 $18,359 $17,765
Net Income (Loss).................... $ 3,442 $ 818 $ (391) $ (369) $ 2,852
Net Income (Loss) Per Share.......... $ .16 $ .04 $ (.02) $ (.02) $ .14
Total Assets (at December 31)........ $46,683 $45,053 $44,096 $40,805 $41,057
Notes Payable (at December 31)....... $11,376 $11,376 $11,376 $15,086 $15,945
Total Long-Term Obligations (at
December 31)....................... $ 1,953 $ 4,110 $ 4,293 $ 1,676 $ 1,148
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
Historically, the Company's cash flows from operating activities have been
insufficient to meet its operating needs, planned capital expenditures and debt
service requirements. The Company has continually sought additional debt and
equity financing in order to fund its mineral development and other investing
activities and experienced serious difficulties obtaining additional financing.
While the Company presently needs additional financing in order to fund its
planned mineral development activities, management believes its ability to
remain a going concern is no longer dependent on obtaining outside financing.
Consequently, management intends to focus additional time and resources on
improving its specialty petrochemical refining operations and reducing the cost
of any required outside financing.
Statements in Items 7 and 7A as well as elsewhere in, or incorporated by
reference in, this Annual Report on Form 10-K regarding the Company's financial
position, business strategy and plans and objectives of the Company's management
for future operations and other statements that are not historical facts, are
"forward-looking statements" as that term is defined under applicable Federal
securities laws. In some case, "forward-looking statements" can be identified by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"contemplates," "proposes," "believes," "estimates," "predicts," "potential" or
"continue" or the negative of such terms and other comparable terminology.
Forward-looking statements are subject to risks, uncertainties and other factors
that could cause actual results to differ materially from those expressed or
implied by such statements. Such risks, uncertainties and factors include, but
are not limited to, general economic conditions domestically and
internationally; insufficient cash flows from operating activities; difficulties
in obtaining financing; outstanding debt and other financial and legal
obligations; competition; industry cycles; feedstock, specialty petrochemical
product and mineral prices; feedstock availability; technological developments;
regulatory changes; environmental matters; foreign government instability;
foreign legal and political concepts; and foreign currency fluctuations, as well
as other risks detailed in the Company's filings with the U.S. Securities and
Exchange Commission, including this Annual Report on Form 10-K, all of which are
difficult to predict and many of which are beyond the Company's control.
LIQUIDITY AND CAPITAL RESOURCES
The Company operates in two business segments, specialty petrochemicals
(which is composed of the entities owned by the Refining Company) and mining.
Its corporate overhead needs are minimal. A discussion of each segment's
liquidity and capital resources follows.
Specialty Petrochemicals Segment. This segment contributes substantially
all of the Company's internally generated cash flows from operating activities.
In order to supplement its cash flows from operating activities, this business
segment has a $2.25 million credit facility with Den norske Bank ASA (the
"Bank"). The terms and conditions of this credit facility are discussed in Note
8 to the Company's Consolidated Financial Statements. During 1998, this segment
used its available cash and debt resources to repay approximately $2.0 million
of outstanding indebtedness owed to Saudi Fal Co. Ltd. which released its second
lien on all of the segment's assets. In a further effort to improve this
segment's liquidity and capital resources,
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the Company converted its previous loan advances into equity and released its
third lien on all of the segment's assets. As a result of these actions, as well
as its recent and expected near term operating results, this segment's cash
flows from operating activities are expected to be adequate to finance its
planned capital expenditures and debt service requirements. In the event this
segment were to undertake a major capital expenditure, such as construction of a
new facility, financing for this activity would most likely come from some
combination of internal resources, a debt placement with a financial institution
or a joint venture partner. Any major capital expenditure requires the Bank's
advance review and approval.
Mining Segment. This segment is in the development stage. Its most
significant asset is the Al Masane mining project in Saudi Arabia, which is a
net user of the Company's available cash and capital resources. As discussed in
Item 2. Properties, management is attempting to finance commercial development
of the Al Masane mining project through the proposed Arabian Mining joint
venture. In the event the proposed joint venture is finalized, the Al Mashreq
partners (which includes certain of the Company's shareholders) would be
obligated to contribute at least $26.0 million of cash as their share of the
venture's capitalization and the Company would be obligated to, at a minimum,
contribute its interests in the Al Masane mining project. The joint venture then
would be responsible for obtaining the remaining amount necessary to finance the
project's commercial development. There is no assurance that the proposed joint
venture will be finalized, or if it is finalized, that the joint venture will be
able to obtain acceptable financing for the project. Obstacles to finalization
of the proposed joint venture and obtaining acceptable financing for the Al
Masane project include, but are not limited to, (i) near recent historically low
market prices for the minerals to be extracted (see related discussion in
"Results of Operations" below); (ii) the unwillingness to date of financial
institutions to accept the Company's guarantee for its portion of any debt
obtained by the proposed joint venture; and (iii) the Company's inability to
negotiate an acceptable joint venture or other agreement(s) with Al Mashreq. In
the event the proposed joint venture is finalized, but cannot obtain acceptable
financing for the project, (i) if the partners decide to continue with the joint
venture, the Company anticipates the joint venture would conduct additional
exploration of the Al Masane project until mineral prices sufficiently recover
in order to improve the project's financial viability or (ii) if the partners
decide not to continue with the joint venture and the Al Masane project reverts
back to the Company (or in the event the proposed joint venture is never
finalized), then the Company would attempt to conduct additional exploration
until mineral prices sufficiently recover in order to improve the project's
financial viability. This scenario may force the Company to attempt to obtain
additional outside financing.
Management also is addressing two other significant financing issues within
this segment. These issues are the $11.0 million note payable due the Saudi
Arabian government and accrued salaries and termination benefits of
approximately $840,000 due employees working in Saudi Arabia (this amount does
not include any amounts due the Company's President and Chief Executive Officer
who also primarily works in Saudi Arabia and is owed approximately $703,000).
Regarding the note payable, this loan was originally due in ten annual
installments beginning in 1984. While the Company has not made any repayments,
it has not received any payment demands or other communications regarding the
note payable from the Saudi government. This despite the fact the Company
remains active in Saudi Arabia and received the Al Masane mineral lease at a
time when it had not made any of the agreed upon repayment installments. Based
on its experience to date, management believes that as long as the Company
diligently attempts to explore and develop the Al Masane project no repayment
demand will be made. The Company recently communicated to the Saudi government
that its delay in repaying the note is a direct result of the government's
lengthy delay in granting the Al Masane lease and requested formal negotiations
to restructure this obligation. Based on its interpretation of the Al Masane
mining lease and other documents, management believes the government is likely
to agree to link repayment of this note to the operating cash flows generated by
the commercial development of the Al Masane project and to a long-term
installment repayment schedule. In the event the Saudi government were to demand
immediate repayment of this obligation, which management considers unlikely, the
Company would be unable to pay the entire amount due. If a satisfactory
rescheduling agreement could be reached, and there are no assurances that one
could be, the Company believes it could obtain the necessary resources to meet
the rescheduled installment payments by making certain changes at the Refining
Company.
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With respect to the accrued salaries and termination benefits due employees
working in Saudi Arabia, the Company plans to continue employing these
individuals until it is able to generate sufficient excess funds to begin
payment of this liability. Management will then begin the process of gradually
releasing certain employees and paying its obligation as they are released from
the Company's employment.
At this time, the Company has no definitive plans for the development of
its domestic mining assets. It periodically receives proposals from outside
parties who are interested in possibly developing or using certain assets.
Management will continue to review these proposals as they are received, but at
this time does not anticipate making any significant domestic mining capital
expenditures or receiving any significant proceeds from the sale or use of these
assets.
If the Company seeks additional outside financing, there is no assurance
that sufficient funds can be obtained. It is also possible that the terms of any
additional financing that the Company would be able to obtain would be
unfavorable to the Company and its existing shareholders.
RESULTS OF OPERATIONS
Comparison of the Years 1998 to 1997
Specialty Petrochemicals Segment. During 1998, total revenues decreased
approximately $1.2 million or 4.1% while the cost of sales decreased
approximately $3.9 million or 17.8% from 1997. Consequently, 1998's gross profit
margin increased approximately $2.8 million or 70.1%. Sales volume decreased
slightly by 2.4%. The average selling price also decreased slightly by 2.5% as a
result of the adverse economic conditions affecting the petroleum refining
industry during much of 1998. As a result of these changes in sales and cost of
sales, the Refining Company significantly increased its gross profit (and net
income) due primarily to lower operating expenses and reduced feedstock costs.
The price of its primary feedstock, natural gasoline, continued to decrease
throughout 1998. Natural gasoline is the heavier liquid produced by natural gas
processing plants and by LPG fractionators. Feedstock prices continued the
decline throughout 1998 that began in the fourth quarter of 1997. Prices in the
fourth quarter of 1998 were almost 25% lower than those experienced in the first
quarter. The Refining Company's reputation for superior product quality and
service reliability in the petrochemical industry's specialty products segment
allowed it to substantially maintain sales volumes and prices during 1998,
thereby permitting it to take advantage of feedstock's reduced cost. Management
expects its feedstock costs to remain near present levels during much of 1999.
Toll processing continued to be a growing contributor to the refinery's
business as fees increased 27% to $.7 million in 1998. The increase in the toll
processing business is indicative of the direction of the U.S. refining and
petrochemical industries. Many larger companies are outsourcing smaller jobs and
processes that were formerly processed internally. The Refining Company has been
in the toll processing business for over 30 years, enjoys a good reputation
within the industry and believes it offers customers several competitive
advantages over other suppliers. Management intends to expand the refinery's
involvement in this area as opportunities arise. Construction has begun on a
unit designed to produce a line of specialty solvents for a major customer on a
multi-year contract. Production is scheduled to begin on April 1, 1999.
The increase in interest income was due to the investment of increased
excess cash while the slight absolute decrease in interest expense was due to
the previously discussed reduction in debt as well as a slight decrease in
interest rates.
Miscellaneous income represents various items that individually are not
significant enough to disclose separately. This includes income from tank and
other rentals, commission income and occasional gains from small asset sales.
The $.2 million decrease in 1998 is due to reduced tank rentals and no rental
income from a building that was sold in 1997.
Mining Segment and General Corporate Expenses. None of the Company's other
operations generate significant operating or other revenues. Minority interest
amounts represent the Pioche minority shareholders' share of Pioche's losses
that are primarily attributable to the costs of maintaining the Nevada mining
properties.
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The Company periodically reviews and evaluates its mineral exploration and
development projects as well as its other mineral properties and related assets.
The recoverability of the Company's carrying values of its development
properties are assessed by comparing the carrying values to estimated future net
cash flows from each property. In 1998, for purposes of estimating future cash
flows, the price assumptions contained in the 1996 update to the Al Masane
project's feasibility study, which was prepared by WGM, were used. See Item 2.
Properties. These price assumptions are averages over the projected life of the
Al Masane mine and are $1.05 per pound for copper, $.60 per pound for zinc, $400
per ounce for gold, and $6.00 per ounce for silver. For its other mineral
properties and related assets, carrying values were compared to estimated net
realizable values based on market comparables. Using these price assumptions, no
asset impairments were evident.
The Company intends to assess the carrying values of its assets on an
ongoing basis. Factors which may affect carrying values include, but are not
limited to, mineral prices, capital cost estimates, the estimated operating
costs of any mines and related processing, ore grade and related metallurgical
characteristics, the design of any mines and the timing of any mineral
production. There are no assurances that, particularly in the event of a
prolonged period of depressed mineral prices, the Company will not be required
to take a material write-down of its mineral properties.
The Company's income tax expense includes $24,800 for the 1998 payment of
its 1997 federal income tax liability (which was due to the alternative minimum
income tax) and $231,000 for its 1998 state tax liability. Due primarily to the
1988 write-off of its coal lease investments, the Company had net operating loss
carryforwards of approximately $28.0 million at December 31, 1998, approximately
$5.9 million and $2.5 million of which are limited to the Coal Company's and
Refining Company's, respectively, future taxable income. These loss
carryforwards expire during the years 1999 through 2011.
Comparison of the Years 1997 to 1996
Specialty Petrochemicals Segment. During 1997, total revenues increased
approximately $4.2 million or 18.9% while the cost of sales increased
approximately $2.8 million or 14.3% from 1996. Consequently, 1997's gross profit
margin increased approximately $1.4 million or 52.6%. Sales volume increased 14%
to 28 million gallons. This was the largest volume achieved by the Refining
Company since it began processing specialty products in 1985. This strong volume
reflected increased sales to existing customers and the results of an increased
marketing effort that resulted in new customers. The plastics industry continued
to experience a steady demand that resulted in the continued growth in the
volume of refined products sold. Its average product selling price was
approximately 4% higher in 1997 compared to 1996. The Refining Company's gross
profit (and net income) increased despite increases in natural gasoline, its
primary feedstock, and natural gas, which is used for fuel, costs during the
first two months of 1997. In March 1997, feedstock prices and natural gas fuel
prices returned to their normal levels that, combined with an increase in the
sales prices for its products, resulted in improved gross and operating margins
for all of 1997. Feedstock costs for all of 1997 were, on average, identical to
1996 costs. The chemical industry, particularly ethylene crackers, continued to
be big users of natural gasoline during 1997. This demand contributed to
feedstock costs remaining higher than in recent years. Feedstock costs peaked
during the period of November 1996 through February of 1997, returned to their
historic levels during most of 1997 and decreased in 1997's fourth quarter.
Toll processing fees slightly decreased in 1997 by approximately $64,000
due to the cancellation of a processing contract. In general, the refinery has
experienced healthy growth in its toll processing business during the past
several years.
The increase in interest income was due to the investment of increased
excess cash. The increase in interest expense was primarily due to an increased
amount of interest bearing debt that resulted from a major debt restructuring in
October 1996. This restructuring included the rolling over of accrued interest
into principal and a higher new interest rate. However, during 1997, interest
rates declined slightly.
The decrease in miscellaneous income is almost entirely attributable to the
1997 sale of an office building that generated rental income.
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Mining Segment and General Corporate Expenses. As previously stated, none
of the Company's other operations generate significant operating or other
revenues. Minority interest amounts represent the Pioche minority shareholders'
share of Pioche's losses, which are primarily attributable to the costs of
maintaining the Nevada mining properties. However, in October 1997, Pioche
entered into an Exploration Agreement and Option to Purchase with a large mining
company that was subsequently terminated in 1998.
The increase in general and administrative expenses was partially
attributable to stock option expenses of $125,000 and $50,000 for the cost of
issuing 50,000 shares of the Company's common stock in 1997.
The Company's net operating loss carryforwards totaled approximately $32.3
million at December 31, 1997. Approximately $5.9 million and $1.7 million were
limited to any future net income of the Coal Company and Refining Company,
respectively. Certain carryforwards were set to expire in 1998 unless they were
used.
OTHER MATTERS
Year 2000. The Company, like most companies, is faced with the Year 2000
issue as a result of the use of computer systems that were designed to process
two digits rather than four in order to define a year. For example, some
computer software may interpret a date using the two digit representation "00"
as the year 1900 instead of the Year 2000. If not corrected, such
misinterpretations could result in system failures or in miscalculations causing
disruptions in operational or financial processing.
The Company began significant efforts to address its Year 2000 exposures in
1998. A project team assessed, remedied or replaced, and will test and implement
Year 2000 compliant computer systems and applications (which consist of
purchased computer applications, hardware, systems software and embedded chip
systems) so that such systems and related processes will continue to operate and
properly process information dated after December 31, 1999. Most of this work
was performed in conjunction with the implementation of necessary data
processing capacity increases.
The initial phase of these plans, an inventory and assessment of potential
problem areas for its information technology ("IT") systems and non-IT systems,
such as embedded technology, is complete. The remediation and replacement phase
for its IT and non-IT systems is substantially complete. The Company estimates
that as of December 31, 1998 it had completed approximately 85% of the
activities in this phase and the remaining tasks should be completed by April
30, 1999. During May 1 through September, 1999, the Company plans to conduct a
complete Year 2000 readiness test as well as a full systems integration test in
an environment that simulates processing conditions that will exist after
December 31, 1999. The Company anticipates that all of its phases will be
completed by September 30, 1999, however, there can be no assurances that this
deadline will be met.
Formal communications will be initiated with major customers and vendors to
assess the Company's potential exposure from their failure to remediate their
own Year 2000 issues. A failure by any of these customers and vendors could
become a significant challenge to the Company's ability to operate its
facilities at affected locations. Customers and vendors to be contacted include
the Refining Company's customers and suppliers. If needed, the Company may
choose to identify and develop alternate customers and storage facilities as
well as alternative providers of products and services. Although the Company has
no means of ensuring the Year 2000 readiness of such customers and vendors, it
will gather information and monitor their compliance.
The Company's total cost of achieving Year 2000 compliant systems is
currently estimated to be $175,000. This amount, which includes both expense and
capital spending, will be funded from the Company's net cash flows from
operating activities. Through December 31, 1998, approximately $150,000 has been
spent for the replacement of hardware and software and capitalized.
The failure to correct a material Year 2000 problem or the inability of any
key customer, key supplier or a governmental agency to make the necessary
computer system changes on a timely basis, could result in interruptions to the
Company's operations or business activities. Such interruptions could have a
material adverse impact on the Company's financial condition, operating results
and cash flows. Due to the general
17
19
uncertainty inherent in the Year 2000 issue, particularly as it relates to the
readiness of the Company's key customers and suppliers, and of governmental
agencies, the Company cannot ascertain at this time whether the consequences of
Year 2000 failures will have a material impact on the Company's financial
condition, operating results or cash flows.
The Company is also developing contingency plans regarding the Year 2000
issue that addresses various scenarios and alternatives. Among other things,
these plans will probably include replacing electronic applications with manual
processes, identifying alternative vendors, adjusting staffing requirements and
increasing raw material inventory levels, as considered necessary. Contingency
plans are expected to be completed by June 30, 1999, and will be updated
regularly as current issues develop or as new issues are identified. However,
there can be no assurances that these contingency plans will be timely completed
or implemented.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The market risk inherent in the Company's financial instruments represents
the potential loss resulting from adverse changes in interest rates, foreign
currency rates and commodity prices. The Company's exposure to interest rate
changes results from its variable rate debt instruments which are vulnerable to
changes in short term United States prime interest rates. At December 31, 1998,
the Company had $1.7 million in variable rate debt outstanding. A hypothetical
10% change in interest rates underlying these borrowings would result in
approximately a $32,000 annual change in the Company's earnings and cash flows.
At December 31, 1997, the Company had $4.0 million in variable rate debt
outstanding and a hypothetical 10% change in interest rates underlying these
borrowings would have resulted in approximately a $38,000 annual change in the
Company's earnings and cash flows.
The Company is also exposed to market risk in the exchange rate of the
Saudi Arabian riyal as measured against the United States dollar. The Company
does not view this exposure as significant and has not acquired or issued any
foreign currency derivative financial instruments. The Company's strategy in
managing its exposure to commodity prices is to purchase options on commodity
based derivative futures contracts when available. At December 31, 1998 and
1997, the Company's investment in such instruments was insignificant.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements of the Company, including the independent
auditor's report thereon, and the financial statement schedules, including the
independent auditor's report thereon, are included elsewhere in this document.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
This information is set forth under the captions "Nominees for Election as
Directors", "Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" of the Company's Proxy Statement for the Company's Annual
Meeting of Shareholders.
ITEM 11. EXECUTIVE COMPENSATION.
This information is set forth under the caption "Executive Compensation" of
the Company's Proxy Statement for the Company's Annual Meeting of Shareholders.
18
20
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
This information is set forth under the caption "Outstanding Capital Stock"
of the Company's Proxy Statement for the Company's Annual Meeting of
Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
This information is set forth under the caption "Other Matters" of the
Company's Proxy Statement for the Company's Annual Meeting of Shareholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. The following financial statements are filed with this Report:
Reports of Independent Accountants.
Consolidated Balance Sheets dated December 31, 1998 and
1997.
Consolidated Statement of Operations for the three years
ended December 31, 1998.
Consolidated Statement of Shareholders' Equity for the three
years ended December 31, 1998.
Consolidated Statement of Cash Flows for the three years
ended December 31, 1998.
Notes to Consolidated Financial Statements.
2. The following financial statement schedules are filed with this
Report:
Schedule II -- Valuation and Qualifying Accounts for the
three years ended December 31, 1998.
3. The following documents are filed or incorporated by reference as
exhibits to this Report. Exhibits marked with an asterisk (*) are
management contracts or a compensatory plan, contract or arrangement.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3(a) -- Certificate of Incorporation of the Company as amended
through the Certificate of Amendment filed with the
Delaware Secretary of State on January 29, 1993
(incorporated by reference to Exhibit 3(a) to the
Company's Quarterly Report on Form 10-Q/A for the quarter
ended September 30, 1994 (File No. 0-6247)).
3(b) -- Bylaws of the Company, as amended through July 6, 1994
(incorporated by reference to Exhibit 3(b) to the
Company's Quarterly Report on Form 10-Q/A for the quarter
ended September 30, 1994 (File No. 0-6247)).
10(a) -- Contract dated July 29, 1971 between the Company,
National Mining Company and Petromin (incorporated by
reference to Exhibit 10(a) to the Company's Quarterly
Report on Form 10-Q/A for the quarter ended September 30,
1994 (File No. 0-6247)).
10(b) -- Loan Agreement dated January 24, 1979 between the
Company, National Mining Company and the Government of
Saudi Arabia (incorporated by reference to Exhibit 10(b)
to the Company's Quarterly Report on Form 10-Q/A for the
quarter ended September 30, 1994 (File No. 0-6247)).
10(c) -- Mining Lease Agreement effective May 22, 1993 by and
between the Ministry of Petroleum and Mineral Resources
and the Company, together with English translation
thereof (incorporated by reference to Exhibit 10(d) to
the Company's Quarterly Report on Form 10-Q/A for the
quarter ended September 30, 1994 (File No. 0-6247)).
19
21
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10(d) -- Stock Option Plan of the Company, as amended
(incorporated by reference to Exhibit 10(e) to the
Company's Quarterly Report on Form 10-Q/A for the quarter
ended September 30, 1994 (File No. 0-6247)).*
10(e) -- 1987 Non-Employee Director Stock Plan (incorporated by
reference to Exhibit 10(f) to the Company's Quarterly
Report on Form 10-Q/A for the quarter ended September 30,
1994 (File No. 0-6247)).*
10(f) -- Phantom Stock Plan of Texas Oil & Chemical Co. II, Inc.
(incorporated by reference to Exhibit 10(g) to the
Company's Quarterly Report on Form 10-Q/A for the quarter
ended September 30, 1994 (File No. 0-6247)).*
10(g) -- Agreement dated March 10, 1988 between Chevron Research
Company and South Hampton Refining Company, together with
related form of proposed Contract of Sale by and between
Chevron Chemical Company and South Hampton Refining
Company (incorporated by reference to Exhibit 10(o) to
the Company's Quarterly Report on Form 10-Q/A for the
quarter ended September 30, 1994 (File No. 0-6247)).
10(h) -- Addendum to the Agreement Relating to AROMAX(R)
Process -- Second Commercial Demonstration dated June 13,
1989 by and between Chevron Research Company and South
Hampton Refining Company (incorporated by reference to
Exhibit 10(p) to the Company's Quarterly Report on Form
10-Q/A for the quarter ended September 30, 1994 (File No.
0-6247)).
10(i) -- Vehicle Lease Service Agreement dated September 28, 1989
by and between Silsbee Trading and Transportation Corp.
and South Hampton Refining Company (incorporated by
reference to Exhibit 10(q) to the Company's Quarterly
Report on Form 10-Q/A for the quarter ended September 30,
1994 (File No. 0-6247)).*
10(j) -- Letter Agreement dated May 3, 1991 between Sheikh Kamal
Adham and the Company (incorporated by reference to
Exhibit 10(t) to the Company's Quarterly Report on Form
10-Q/A for the quarter ended September 30, 1994 (File No.
0-6247)).
10(k) -- Promissory Note dated February 17, 1994 from Hatem
El-Khalidi to the Company (incorporated by reference to
Exhibit 10(u) to the Company's Quarterly Report on Form
10-Q/A for the quarter ended September 30, 1994 (File No.
0-6247)).*
10(l) -- Letter Agreement dated August 15, 1995 between Hatem
El-Khalidi and the Company (incorporated by reference to
Exhibit 10(v) to the Company's Annual Report on Form 10-K
for the year ended December 31, 1995 (File No. 0-6247)).*
10(m) -- Letter Agreement dated August 24, 1995 between Sheikh
Kamal Adham and the Company (incorporated by reference to
Exhibit 10(w) to the Company's Annual Report on Form 10-K
for the year ended December 31, 1995 (File No. 0-6247)).
10(n) -- Letter Agreement dated October 23, 1995 between Sheikh
Fahad Al-Athel and the Company (incorporated by reference
to Exhibit 10(x) to the Company's Annual Report on Form
10-K for the year ended December 31, 1995 (File No.
0-6247)).
10(o) -- Amended and Restated Credit Agreement dated December 28,
1998 between South Hampton Refining Company and Den
norske Bank ASA, together with related Promissory Note.
10(p) -- Letter Agreement dated November 30, 1996 between Sheikh
Fahad Al-Athel and the Company (incorporated by reference
to Exhibit 10(bb) to the Company's Annual Report on Form
10-K for the year ended December 31, 1996 (File No.
0-6247)).
20
22
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10(q) -- Joint Venture Agreement dated November 5, 1997 initialed
by Al Mashreq Company for Mining Investments and the
Company (incorporated by reference to Exhibit 10(r) to
the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 0-6247)).
21 -- Subsidiaries (incorporated by reference to Exhibit 21 to
the Company's Quarterly Report on Form 10-Q/A for the
quarter ended September 30, 1994 (File No. 0-6247)).
27 -- Financial Data Schedule.
(b) No reports on Form 8-K were filed during the last quarter of the period
covered by this Report.
21
23
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS that each of Arabian Shield Development
Company, a Delaware corporation, and the undersigned directors and officers of
Arabian Shield Development Company, hereby constitutes and appoints John A.
Crichton its or his true and lawful attorney-in-fact and agent, for it or him
and in its or his name, place and stead, in any and all capacities, with full
power to act alone, to sign any and all amendments to this Report, and to file
each such amendment to the Report, with all exhibits thereto, and any and all
other documents in connection therewith, with the Securities and Exchange
Commission, hereby granting unto said attorney-in-fact and agent full power and
authority to do and perform any and all acts and things requisite and necessary
to be done in and about the premises as fully to all intents and purposes as it
or he might or could do in person, hereby ratifying and confirming all that said
attorney-in-fact and agent may lawfully do or cause to be done by virtue hereof.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ARABIAN SHIELD DEVELOPMENT COMPANY
By: /s/ HATEM EL-KHALIDI
-------------------------------------
Hatem El-Khalidi,
President and Chief Executive Officer
Dated: March 31, 1999
22
24
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the Company
in the capacities indicated on March 31, 1999.
SIGNATURE TITLE
--------- -----
/s/ HATEM EL-KHALIDI President, Chief Executive Officer and
- ----------------------------------------------------- Director (principal executive officer)
Hatem El-Khalidi
/s/ DREW WILSON, JR. Secretary and Treasurer
- ----------------------------------------------------- (principal financial and accounting
Drew Wilson, Jr. officer)
/s/ JOHN A. CRICHTON Chairman of the Board and Director
- -----------------------------------------------------
John A. Crichton
/s/ MOHAMMED O. AL-OMAIR Director
- -----------------------------------------------------
Mohammed O. Al-Omair
/s/ GHAZI SULTAN Director
- -----------------------------------------------------
Ghazi Sultan
23
25
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
Arabian Shield Development
We have audited the accompanying consolidated balance sheets of Arabian
Shield Development Company and Subsidiaries as of December 31, 1998 and 1997,
and the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above, present fairly,
in all material respects, the consolidated financial position of Arabian Shield
Development Company and Subsidiaries as of December 31, 1998 and 1997, and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles.
GRANT THORNTON LLP
Dallas, Texas
February 19, 1999
F-1
26
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
-------------------------
1998 1997
----------- -----------
CURRENT ASSETS
Cash and cash equivalents................................. $ 1,907,242 $ 534,086
Short-term investments.................................... 30,636 407,542
Trade receivables......................................... 2,779,964 3,047,311
Inventories............................................... 178,714 548,320
----------- -----------
Total current assets.............................. 4,896,556 4,537,259
REFINERY PLANT, PIPELINE AND EQUIPMENT -- AT COST........... 7,151,134 5,926,188
LESS ACCUMULATED DEPRECIATION............................. (3,651,626) (3,238,623)
----------- -----------
REFINERY PLANT, PIPELINE AND EQUIPMENT, NET................. 3,499,508 2,687,565
AL MASANE PROJECT......................................... 34,121,501 33,522,427
OTHER INTERESTS IN SAUDI ARABIA........................... 2,431,248 2,431,248
MINERAL PROPERTIES IN THE UNITED STATES................... 1,280,656 1,411,190
OTHER ASSETS.............................................. 453,854 463,230
----------- -----------
TOTAL ASSETS...................................... $46,683,323 $45,052,919
=========== ===========
F-2
27
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS' EQUITY
DECEMBER 31,
--------------------------
1998 1997
----------- ------------
CURRENT LIABILITIES
Accounts payable -- trade................................. $ 668,683 $ 790,759
Accrued liabilities....................................... 1,027,809 673,511
Accrued liabilities in Saudi Arabia....................... 1,444,156 1,283,401
Notes payable............................................. 11,375,780 11,375,780
Current portion of long-term debt......................... 498,000 598,000
Current portion of long-term obligations.................. -- 37,915
----------- ------------
Total current liabilities......................... 15,014,428 14,759,366
LONG-TERM DEBT.............................................. 1,250,000 3,435,773
LONG-TERM OBLIGATIONS....................................... -- 21,205
ACCRUED LIABILITIES IN SAUDI ARABIA, NET.................... 703,214 653,149
DEFERRED REVENUE............................................ 98,677 114,181
COMMITMENTS AND CONTINGENCIES............................... -- --
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY................ 909,600 1,044,487
SHAREHOLDERS' EQUITY
Common stock -- authorized 40,000,000 shares of $.10 par
value; issued and outstanding, 22,019,494 shares in
1998 and 21,861,494 shares in 1997..................... 2,201,949 2,186,149
Additional paid-in capital................................ 36,101,150 35,875,950
Accumulated deficit....................................... (9,595,695) (13,037,341)
----------- ------------
Total shareholders' equity........................ 28,707,404 25,024,758
----------- ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $46,683,323 $ 45,052,919
=========== ============
The accompanying notes are an integral part of these statements.
F-3
28
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
1998 1997 1996
----------- ----------- -----------
Revenues
Refined product sales............................... $24,350,938 $25,591,600 $21,367,438
Processing fees..................................... 738,237 582,519 646,848
----------- ----------- -----------
25,089,175 26,174,119 22,014,286
Operating costs and expenses
Cost of refined product sales and processing........ 18,192,488 22,119,668 19,357,737
General and administrative.......................... 2,669,088 2,695,043 2,284,422
Depreciation and amortization....................... 428,743 538,240 693,251
----------- ----------- -----------
21,290,319 25,352,951 22,335,410
----------- ----------- -----------
Operating income (loss)............................... 3,798,856 821,168 (321,124)
Other income (expense)
Interest income..................................... 112,129 51,062 25,310
Interest expense.................................... (346,117) (405,270) (336,979)
Minority interest................................... 7,905 19,282 13,072
Miscellaneous income................................ 124,650 332,122 228,825
----------- ----------- -----------
Income (loss) before income taxes..................... 3,697,423 818,364 (390,896)
Income tax expense.................................... 255,777 -- --
----------- ----------- -----------
Net income (loss)..................................... $ 3,441,646 $ 818,364 $ (390,896)
=========== =========== ===========
Net income (loss) per common share:
Basic............................................... $ 0.16 $ 0.04 $ (0.02)
=========== =========== ===========
Diluted............................................. $ 0.14 $ 0.04 $ (0.02)
=========== =========== ===========
Weighted average number of common and common
equivalent shares outstanding:
Basic............................................... 21,995,735 21,306,040 20,286,208
=========== =========== ===========
Diluted............................................. 25,649,695 22,017,652 20,286,208
=========== =========== ===========
The accompanying notes are an integral part of these statements.
F-4
29
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ADDITIONAL RECEIVABLE
----------------------- PAID-IN FROM ACCUMULATED
SHARES AMOUNT CAPITAL SHAREHOLDER DEFICIT TOTAL
---------- ---------- ----------- ----------- ------------ -----------
January 1, 1996............ 20,206,494 $2,020,649 $33,210,750 $(126,000) $(13,464,809) $21,640,590
Common stock sold........ 450,000 45,000 405,000 -- -- 450,000
Common stock issued for
services............... 300,000 30,000 520,000 -- -- 550,000
Stock options issued..... -- -- 796,950 -- -- 796,950
Net loss................. -- -- -- -- (390,896) (390,896)
---------- ---------- ----------- --------- ------------ -----------
December 31, 1996.......... 20,956,494 2,095,649 34,932,700 (126,000) (13,855,705) 23,046,644
Common stock sold........ 500,000 50,000 450,000 -- -- 500,000
Common stock issued for
services............... 50,000 5,000 45,000 -- -- 50,000
Common stock issued on
debt conversion........ 345,000 34,500 310,500 -- -- 345,000
Stock options
exercised.............. 10,000 1,000 12,750 -- -- 13,750
Stock options issued for
services............... -- -- 125,000 -- -- 125,000
Net income............... -- -- -- -- 818,364 818,364
---------- ---------- ----------- --------- ------------ -----------
December 31, 1997.......... 21,861,494 2,186,149 35,875,950 (126,000) (13,037,341) 24,898,758
Common stock sold........ 100,000 10,000 140,000 -- -- 150,000
Stock options
exercised.............. 58,000 5,800 85,200 -- -- 91,000
Offset of receivable
against related
payables............... -- -- -- 126,000 -- 126,000
Net income............... -- -- -- -- 3,441,646 3,441,646
---------- ---------- ----------- --------- ------------ -----------
December 31, 1998.......... 22,019,494 $2,201,949 36,101,150 $ -- $ (9,595,695) $28,707,404
========== ========== =========== ========= ============ ===========
The accompanying notes are an integral part of this statement.
F-5
30
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
1998 1997 1996
----------- --------- ---------
Operating activities
Net income (loss).................................... $ 3,441,646 $ 818,364 $(390,896)
Adjustments for non-cash transactions
Depreciation and amortization..................... 428,743 538,240 693,251
Common stock and stock options issued for
services........................................ -- 175,000 --
Decrease in deferred revenue...................... (15,504) (15,504) (15,504)
Effects of changes in operating assets and
liabilities
Increase in trade receivables..................... 267,347 (403,620) (845,570)
Decrease (increase) in inventories................ 369,606 17,026 (134,614)
Decrease in other assets.......................... 9,376 42,336 135,287
(Decrease) increase in accounts payable and
accrued liabilities............................. 232,222 (464,852) 454,810
Other................................................ (150,627) (7,945) (70,529)
----------- --------- ---------
Net cash provided by (used in) operating
activities................................. 4,582,809 699,045 (173,765)
----------- --------- ---------
Investing activities
Additions to short-term investments.................. (14,387) (108,816) (4,116)
Proceeds from sale of short-term investments......... 391,293 -- --
Additions to Al Masane Project....................... (599,074) (639,589) (451,110)
Additions to refinery plant, pipeline and
equipment......................................... (1,224,946) (167,336) (195,076)
Reduction in mineral properties in the United
States............................................ 130,534 7,425 --
Decrease in cash in Saudi Arabia..................... -- -- 396,809
Increase in accrued liabilities in Saudi Arabia...... 210,820 174,178 53,450
----------- --------- ---------
Net cash used in investing activities........ (1,105,760) (734,138) (200,043)
----------- --------- ---------
Financing activities
Common stock sold.................................... 241,000 513,750 450,000
Additions to notes payable and long-term
obligations....................................... 1,985,000 200,000 445,773
Reduction of notes payable and long-term
obligations....................................... (4,329,893) (529,861) (438,714)
----------- --------- ---------
Net cash provided by (used in) financing
activities................................. (2,103,893) 183,889 457,059
----------- --------- ---------
Net increase in cash................................... 1,373,156 148,796 83,251
Cash and cash equivalents at beginning of year......... 534,086 385,290 302,039
----------- --------- ---------
Cash and cash equivalents at end of year............... $ 1,907,242 $ 534,086 $ 385,290
=========== ========= =========
F-6
31
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- BUSINESS AND OPERATIONS OF THE COMPANY
Arabian Shield Development Company (the "Company") was organized as a
Delaware corporation in 1967. The Company's principal business activities
include refining various specialty petrochemical products (also referred to as
the "Refining Segment") and developing mineral properties in Saudi Arabia and
the United States (also referred to as the "Mining Segment"). All of its mineral
properties are presently undeveloped and require significant capital
expenditures before beginning any commercial operations (see Notes 2, 6 and 7).
The Company's Refining Segment activities are primarily conducted through a
wholly-owned subsidiary, American Shield Refining Company (the "Refining
Company"), which owns all of the capital stock of Texas Oil and Chemical Co. II,
Inc. ("TOCCO"). TOCCO owns all of the capital stock of South Hampton Refining
Company ("South Hampton"), and South Hampton owns all of the capital stock of
Gulf State Pipe Line Company, Inc. ("Gulf State"). South Hampton owns and
operates a specialty petrochemical products refinery near Silsbee, Texas that is
one of the largest domestic manufacturers of pentanes. Gulf State owns and
operates three pipelines which connect the South Hampton refinery to a natural
gas line, to South Hampton's truck and rail loading terminal and to a marine
terminal owned by an unaffiliated third party. The Company also directly owns
all of American Shield Coal Company (the "Coal Company") and approximately 51%
of the capital stock of a Nevada mining company, Pioche-Ely Valley Mines, Inc.
("Pioche"). Neither the Coal Company nor Pioche conduct any substantial business
activities. The Coal Company, Pioche and the Company's mineral properties in
Saudi Arabia constitute its Mining Segment.
The Company consolidates all subsidiaries for which it has majority
ownership or voting control that is other than temporary. All material
intercompany accounts and transactions are eliminated.
NOTE 2 -- BUSINESS RISKS
Historically, the Company's cash flows from operating activities have been
insufficient to meet its operating needs, planned capital expenditures and debt
service requirements. The Company has continually sought additional debt and
equity financing in order to fund its mineral development and other investing
activities and experienced serious difficulties obtaining additional financing.
While the Company presently needs additional financing in order to fund its
planned mineral development activities, management believes its ability to
remain a going concern is no longer dependent on obtaining outside financing.
Consequently, management intends to focus additional time and resources on
improving its specialty petrochemical refining operations and reducing the cost
of any required outside financing.
The Company's mining segment is in the development stage. Its most
significant asset is the Al Masane mining project in Saudi Arabia, which is a
net user of the Company's available cash and capital resources. As discussed in
Note 6, management is attempting to finance commercial development of the Al
Masane mining project through the proposed Arabian Mining joint venture. In the
event the proposed joint venture is finalized, the Al Mashreq partners (which
includes certain of the Company's shareholders) would be obligated to contribute
at least $26.0 million of cash as their share of the venture's capitalization
and the Company would be obligated to, at a minimum, contribute its interests in
the Al Masane mining project.
The joint venture would then be responsible for obtaining the remaining
amount necessary to finance the project's commercial development. There is no
assurance that the proposed joint venture will be finalized, or if it is
finalized, that the joint venture will be able to obtain acceptable financing
for the project. Obstacles to finalization of the proposed joint venture and
obtaining acceptable financing for the Al Masane project include, but are not
limited to (i) recent near historically low market prices for the minerals to be
extracted; (ii) the unwillingness of financial institutions to accept the
Company's guarantee for its portion of any debt obtained by the proposed joint
venture; and (iii) the Company's inability to negotiate an acceptable joint
venture or other agreements with Al Mashreq. In the event the proposed joint
venture is finalized, but
F-7
32
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
acceptable financing for the project is not obtainable and (i) the partners
decide to continue with the joint venture, the Company anticipates the joint
venture would conduct additional exploration of the Al Masane project until
financing is available or (ii) the partners decide not to continue with the
joint venture and the Al Masane project reverts back to the Company (or in the
event the proposed joint venture is never finalized), then the Company would
attempt to conduct additional exploration. This scenario may force the Company
to attempt to obtain additional outside financing.
Management also is addressing two other significant financing issues within
this segment. These issues are the $11.0 million note payable due the Saudi
Arabian government and accrued salaries and termination benefits of
approximately $840,000 due employees working in Saudi Arabia (this amount does
not include any amounts due the Company's President and Chief Executive Officer
who also primarily works in Saudi Arabia and is owed approximately $703,000).
Regarding the note payable, this loan was originally due in ten annual
installments beginning in 1984. While the Company has not made any repayments,
it has not received any payment demands or other communications from the Saudi
government regarding the note payable. This is despite the fact the Company
remains active in Saudi Arabia and received the Al Masane mineral lease at a
time when it had not made any of the agreed upon repayment installments. Based
on its experience to date, management believes as long as the Company diligently
attempts to explore and develop the Al Masane project that no repayment demand
will be made. The Company recently communicated to the Saudi government that its
delay in repaying the note is a direct result of the government's lengthy delay
in granting the Al Masane lease and requested formal negotiations to restructure
this obligation. Based on its interpretation of the Al Masane mining lease and
other documents, management believes the government is likely to agree to link
repayment of this note to the operating cash flows generated by the commercial
development of the Al Masane project which would result in a long-term
installment repayment schedule. In the event the Saudi government were to demand
immediate repayment of this obligation, which management considers unlikely, the
Company would be unable to pay the entire amount due. If a satisfactory
rescheduling agreement could be reached, and there are no assurances that one
could be, the Company believes it could obtain the necessary resources to meet
the rescheduled installment payments by making certain changes at the Refining
Company.
With respect to the accrued salaries and termination benefits due employees
working in Saudi Arabia, the Company plans to continue employing these
individuals until it is able to generate sufficient excess funds to begin
payment of this liability. Management will then begin the process of gradually
releasing certain employees and paying its obligation as they are released from
the Company's employment.
A significant component of the Company's assets consists of undeveloped
mineral deposits. There is no assurance that the Company will ultimately
successfully develop either the Al Masane project or any of the other properties
discussed in Notes 6 and 7, and if, developed, whether the mineral acquisition,
development and development costs incurred will be recovered. The recovery of
these costs is dependent upon a number of factors and future events, many of
which are beyond the Company's control. Furthermore, the Company's ability to
develop and realize its investment in these properties is dependent upon (i)
obtaining significant additional financing and (ii) attaining successful
operations from one or more of these projects.
The Company periodically reviews and evaluates its mineral exploration and
development projects as well as its other mineral properties and related assets.
The recoverability of the Company's carrying values of its development
properties are assessed by comparing the carrying values to estimated future net
cash flows from each property. Based upon a 1996 updated feasibility study by
Watts, Griffis and McOuat Ltd., projected positive cash flows, net of repayment
of debt, are $95.1 million over the life of the project. Prices used in the
feasibility study were $1.05 per pound for copper, $.60 per pound for zinc, $400
per ounce for gold and $6.00 per ounce for silver. Although present mineral
prices are less than those used in the feasibility study, the Company believes
that these price declines are not permanent and that the prior assumptions used
in the study are still appropriate.
F-8
33
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In accordance with the provisions of Statement of Financial Accounting
Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long Lived Assets to be Disposed of, which was adopted in 1996, the Company
intends to assess the carrying values of its assets on an ongoing basis. Factors
which may affect carrying values include, but are not limited to, mineral
prices, capital cost estimates, the estimated operating costs of any mines and
related processing, ore grade and related metallurgical characteristics, the
design of any mines and the timing of any mineral production. There are no
assurances that, particularly in the event of a prolonged period of depressed
mineral prices, the Company will not be required to take a material write-down
of its mineral properties.
NOTE 3 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash, Cash Equivalents and Short-Term Investments -- The Company's
principal bank and short-term investing activities are with local and national
financial institutions. Short-term investments with an original maturity of
three months or less are classified as cash equivalents. At December 31, 1998
and 1997, the Company held United States Treasury obligations with original
maturities of less than one year that the Company intends to hold until
maturity. At December 31, 1998, the fair value of these items approximated their
carrying values. Cash balances may, at times exceed federally insured limits.
The Company has not experienced any losses in its cash and short-term investment
accounts and does not believe it is exposed to any significant such risks.
Inventories -- Refined products and feedstock are recorded at the lower of
cost, determined on the last-in, first-out method (LIFO), or market.
Mineral Exploration and Development Costs -- All costs related to the
acquisition, exploration, and development of mineral deposits are capitalized
until such time as (1) the Company commences commercial exploitation of the
related mineral deposits at which time the costs will be amortized, (2) the
related project is abandoned and the capitalized costs are charged to
operations, or (3) when any or all deferred costs are permanently impaired. At
December 31, 1998, none of the projects described in Notes 6 and 7 had reached
the commercial exploitation stage. No indirect overhead or general and
administrative costs have been allocated to any of the projects.
Refinery Plant, Pipeline and Equipment -- Refinery plant, pipeline and
equipment are stated at cost. Depreciation is provided over the estimated
service lives using the straight-line method. Gains and losses from disposition
are included in operations in the period incurred.
Other Assets -- Other assets include catalysts used in refinery operations,
prepaid expenses, a note receivable and certain refinery assets which are being
leased to a third party.
Environmental Liabilities -- Remediation costs are accrued based on
estimates of known environmental remediation exposure. Such accruals are
recorded even if uncertainties exist over the ultimate cost of the remediation.
Ongoing environmental compliance costs, including maintenance and monitoring
costs, are expensed as incurred.
Deferred Revenue -- Deferred revenue represents funds advanced by a
supplier and customer for equipment purchases and is being amortized over a 15
year period.
Statements of Cash Flows -- In the statements of cash flows, cash includes
cash held in the United States and Saudi Arabia. Significant noncash changes in
financial position in 1997 include the issuance of 345,000 shares of common
stock at $1.00 per share for the conversion of $345,000 of indebtedness (Note 9)
as well as the issuance of stock and options for services, valued at a total of
$175,000, which is included in general and administrative expenses (Note 10).
Transactions of this type in 1996 include a restructure of debt to include
$445,773 of accrued interest in the loan principal, as well as the issuance of
stock and options for services, valued at a total of $1,346,950, which is
capitalized as a cost of the Al Masane Project (Note 6).
F-9
34
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net Income (Loss) Per Share -- In 1997, the Company adopted the provisions
of Statement of Financial Accounting Standards No. 128, Earnings per Share (SFAS
No. 128). In accordance with SFAS No. 128, the Company computes basic income per
common share based on the weighted-average number of common shares outstanding.
Diluted income per common share is computed based on the weighted average number
of common shares outstanding plus the number of additional common shares that
would have been outstanding if dilutive potential common shares, consisting of
stock options and shares issuable upon conversion of debt, had been issued (Note
13).
Foreign Currency and Operations -- Assets and liabilities denominated in
foreign currencies, principally Saudi Riyals, are translated at rates in effect
at the time the transaction occurs. There has been no significant change in the
exchange rate for Saudi Riyals to the United States dollar during the period
covered by these financial statements. Due to the stability of the Saudi Riyals,
the Company feels it has no material exposure to foreign currency risks and does
not employ any practices to minimize any such risks. It is anticipated that its
products in Saudi Arabia will be sold in US dollars.
The Company's foreign operations have been, and will continue to be,
affected by periodic changes or developments in Saudi Arabia's political and
economic conditions as well as changes in their laws and regulations. Any such
changes could have a material adverse effect on the Company's financial
condition, operating results or cash flows.
Saudi Arabian investors, including certain members of the Company's board
of directors, own approximately 62% of the Company's outstanding common stock at
December 31, 1998.
Management Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Stock-Based Compensation -- Statement of financial Accounting Standards No.
123, Accounting for Stock-Based Compensation ("Statement No. 123") establishes
accounting and reporting standards for various stock-based compensation plans.
Statement No. 123 encourages the adoption of a fair value based method of
accounting for employee stock options, but permits continued application of the
accounting method prescribed by Accounting Principles Board Opinion No. 25
("Opinion 25"), Accounting for Stock Issued to Employees. The Company has
adopted only the disclosure requirements of Statement 123. Accordingly, the
compensation expense of employee stock options is the excess, if any, of the
quoted market price of the Company's common stock at the grant date over the
amount the employee must pay to acquire the stock, Note 10 includes pro forma,
disclosures of net income (loss) and income (loss) per share as if the Company
had adopted the fair value based method of accounting set forth in Statement
123.
Hedging Program -- The Company's refining segment uses a hedging program to
decrease the price volatility of its natural gas fuel requirements. Gains or
losses related to these contracts are recognized in the period when the
contracts expire. For each of the years ended December 31, 1998, 1997 and 1996
the net recognized gain (loss) from hedging transactions was ($74,500), $46,000
and $0, respectively. At December 31, 1998, the Company had pledged a $100,000
bank letter of credit as collateral for its unpaid natural gas purchases.
F-10
35
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 -- CONCENTRATIONS OF CREDIT RISK
The refining segment sells its products and services to companies in the
chemical and plastics industries. It performs periodic credit evaluations of its
customers and does not require collateral from its customers. The Company's
largest customer accounted for 10% of its total revenues in 1998 and 1997 and
17% of its total revenues in 1996. It has incurred minimal credit losses. The
carrying amount of accounts receivable approximates fair value at December 31,
1998.
NOTE 5 -- INVENTORIES
Inventories include the following at December 31:
1998 1997
-------- --------
Refinery feedstock.......................................... $ -- $ 86,591
Refined products............................................ 178,714 461,729
-------- --------
Total inventories................................. $178,714 $548,320
======== ========
At December 31, 1998 and 1997, the LIFO inventory value approximated
current cost.
NOTE 6 -- MINERAL EXPLORATION AND DEVELOPMENT COSTS IN SAUDI ARABIA
In the accompanying consolidated financial statements, the deferred
development costs have been presented based on the related projects' geographic
location within Saudi Arabia. This includes the "Al Masane Project" (the
"Project") and "Other Interests in Saudi Arabia" which primarily pertains to the
costs of rentals, field offices and camps, core drilling and labor incurred at
the Wadi Qatari and Jebel Hoff properties.
In 1971, the Saudi Arabian government awarded the Company exclusive mineral
exploration licenses to explore and develop the Wadi Qatari area in southwestern
Saudi Arabia. The Company was subsequently awarded an additional license in 1977
for an area north of Wadi Qatari at Jebel Harr. While these licenses have
expired, the Company has received verbal assurance from Saudi Arabian government
officials that the licenses will be extended as long as exploratory work is
being carried out in the areas that they covered. However, no formal extensions
from the government have been obtained. In addition, the Company applied for an
exploration license covering an area surrounding the Al Masane mining lease
area, which is referred to as the Greater Al Masane area. Although a license has
not been formally granted for the Greater Al Masane area, the Company has been
authorized in writing by the Saudi Arabian government to carry out exploration
work on the area. The Company has incurred mineral exploration costs in each of
these areas and intends to formalize its claims.
The Al Masane project, consisting of an area of approximately 44 square
kilometers, contains extensive ancient mineral workings and smelters. From
ancient inscriptions in the area, it is believed that mining activities went on
sporadically from 1000 BC to 700 AD. The ancients are believed to have extracted
mainly gold, silver and copper. The Project includes various quantities of
proved zinc, copper, gold and silver reserves.
As the holder of the Al Masane mining lease, the Company is solely
responsible to the Saudi Arabian government for the rental payments and other
obligations provided for by the mining lease and repayment of the previously
discussed $11 million loan. The Company's interpretation of the mining lease is
that repayment of this loan will be made in accordance with a repayment schedule
to be agreed upon with the Saudi Arabian government from the Company's share of
the project's cash flows. The initial term of the lease is for a period of
thirty (30) years from May 22, 1993, with the Company having the option to renew
or extend the term of the lease for additional periods not to exceed twenty (20)
years. Under the lease, the Company is obligated to pay advance surface rental
in the amount of ten thousand Saudi Riyals (approximately $2,667 at the current
F-11
36
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
exchange rate) per square kilometer per year (approximately $117,300 annually)
during the period of the lease. It is contemplated that responsibility for the
payment of all future rental payments would be assumed by the proposed Arabian
Mining joint venture when title to the Al Masane mining lease is transferred to
it. In addition, the Company must pay income tax in accordance with the income
tax laws of Saudi Arabia then in force and pay all infrastructure costs. The
Saudi Arabian Mining Code provides that income tax will not be due during the
first stage of mining operations, which is the period of five years starting
from the earlier of (i) the date of the first sale of products or (ii) the
beginning of the fourth year since the issue of the mining lease. The lease
gives the Saudi Arabian government priority to purchase any gold production from
the project as well as the right to purchase up to 10% of the annual production
of other minerals on the same terms and conditions then available to other
similar buyers and at current prices then prevailing in the free market.
Furthermore, the lease contains provisions requiring that preferences be given
to Saudi Arabian suppliers and contractors, that the Company employ Saudi
Arabian citizens and provide training to Saudi Arabian personnel.
In order to commercially develop the Al Masane project, which has a
projected development cost of $88.6 million, the Company plans to enter into the
Arabian Mining joint venture with Al Mashreq. The following summarizes certain
proposed terms and conditions of the planned joint venture. The Company
anticipates that, once established, Arabian Mining would attempt to finance the
project and would be responsible for the construction and operation of the
mining facilities. In the event the Arabian Mining joint venture is established,
the Company would be obligated to transfer title to the mining lease as well as
its beneficial interest in the Al Masane project to the planned joint venture.
It is also possible that the Company would be required to transfer its other
Saudi mining interests to the planned joint venture. In the event Arabian Mining
is unable to obtain acceptable financing for the project by a date to be agreed
upon, then either joint venture partner may terminate the joint venture
agreement. In this event, full title to the mining lease and other interests, if
any, that the Company transferred to Arabian Mining would revert back to the
Company. If the joint venture is terminated, the Company may be liable to Al
Mashreq for any prior surface rentals and other such costs which either Al
Mashreq or the planned joint venture paid. At December 31, 1998 the amount of
these costs paid by Al Mashreq was $469,333.
Pursuant to the mining lease agreement, when the Al Masane project is
profitable the Company is obligated to form a Saudi public stock company with
the Petroleum Mineral Organization ("Petromin"). Petromin is the Saudi Arabian
government's official mining and petroleum company. In 1994, the Company
received instructions from the Saudi Ministry of Petroleum and Mineral Resources
stating that it is possible for the Company to form a Saudi company without
Petromin, but the sale of stock to the Saudi public could not occur until the
mine's commercial operations were profitable for at least two years. The
instructions added that Petromin still had the right to purchase shares in the
Saudi public stock company any time it desires. The joint venture partners
contemplate Arabian Mining would be transformed into a Saudi public stock
company sometime after it has been profitable for two years. At that time, the
Company and Al Mashreq would own no less than 50% of the shares of the
contemplated Saudi public stock company, Petromin would have an option to
acquire up to 25% of the shares and the remaining shares would be offered for
sale in Saudi Arabia pursuant to a public stock subscription offering. Title to
the mining lease and the other obligations specified in the mining lease will be
transferred to the Saudi public stock company, However, the Company would remain
responsible for the repaying the $11 million loan to the Saudi Arabian
government.
F-12
37
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred development costs of the Al Masane Project at December 31, 1997,
1996 and 1995, and the changes in these amounts for each of the three years then
ended are detailed below:
BALANCE AT BALANCE AT BALANCE AT
DECEMBER 31, ACTIVITY DECEMBER 31, ACTIVITY DECEMBER 31, ACTIVITY
1998 FOR 1998 1997 FOR 1997 1996 FOR 1996
------------ -------- ------------ -------- ------------ ----------
Property and equipment:
Mining equipment.......... 2,160,206 $ 2,160,206 $ 2,160,206
Construction costs........ 3,140,493 3,140,493 3,140,493
----------- ----------- -----------
Total............. 5,300,699 5,300,699 5,300,699
Other costs:
Labor, consulting services
and project
administration costs... 19,583,616 $438,320 19,145,296 $562,523 18,592,773 $1,942,596
Materials and
maintenance............ 6,168,880 219 6,168,661 737 6,167,924 914
Feasibility study......... 2,907,771 -- 2,907,771 76,329 2,831,442 41,455
----------- -------- ----------- -------- ----------- ----------
Total............. 28,660,267 438,539 28,221,728 639,589 27,582,139 1,984,955
----------- -------- ----------- -------- ----------- ----------
$33,960,966 $438,539 $33,522,427 $639,589 $32,882,838 $1,984,955
=========== ======== =========== ======== =========== ==========
The deferred development costs of the "Other Interests in Saudi Arabia", in
the total amount of approximately $2.4 million, consist of approximately $1.5
million associated with the Greater Al Masane area and the balance of
approximately $900,000 is associated primarily with the Wadi Qatan and Jebel
Harr areas. In the event exploration licenses for these areas are not granted,
then all or a significant amount of deferred development costs relating thereto
would be written off.
NOTE 7 -- MINERAL PROPERTIES IN THE UNITED STATES
The principal assets of Pioche are an undivided interest in 48 patented and
80 unpatented mining claims and a 300 ton-per-day mill located on the
aforementioned properties in the Pioche Mining District in southeastern Nevada.
Due to the lack of capital, the properties held by Pioche have not been
commercially operated for approximately 35 years. However, in 1997 Pioche and a
prominent mining company entered into an agreement regarding certain claims. As
a result of this agreement, which was terminated in November 1998, Pioche
received $50,000.
The Company has an option (which expires in 2002) to buy 720,000 shares
(approximately 10% of the outstanding shares) of Pioche common stock at $0.20
per share.
F-13
38
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- NOTES PAYABLE, LONG-TERM DEBT AND LONG-TERM OBLIGATIONS
Notes payable, long-term debt and long-term obligations at December 31 are
summarized as follows:
1998 1997
----------- -----------
Notes payable:
Secured note to Saudi Arabian government. See (A)........ $11,000,000 $11,000,000
Unsecured demand notes payable to Saudi investors........ 363,280 363,280
Other.................................................... 12,500 12,500
----------- -----------
Total............................................ $11,375,780 $11,375,780
=========== ===========
Long-term debt:
Revolving bank note. See (B)............................. $ 1,250,000 $ 1,590,000
Unsecured note to a Saudi company. See (C)............... -- 1,945,773
Unsecured notes to foreign investors. See (D)............ 498,000 498,000
Total............................................ 1,748,000 4,033,773
Less current portion..................................... (498,000) (598,000)
----------- -----------
Total............................................ $ 1,250,000 3,435,773
=========== ===========
Long-term obligations:
Noninterest-bearing note to a supplier and customer for
capital improvements.................................. $ -- $ 24,000
Deferred compensation contracts.......................... -- 35,120
----------- -----------
Total............................................ -- 59,120
Less current portion..................................... -- (37,915)
----------- -----------
Total............................................ $ -- $ 21,205
=========== ===========
- ---------------
(A) The Company has an interest-free loan of $11,000,000 from the Saudi Arabia
Ministry of Finance and National Economy, the proceeds of which were used
to finance the initial development phase of the Al Masane Project. The loan
was repayable in ten equal annual installments of $1,100,000, with the
initial installment payable on December 31, 1984. None of the ten scheduled
payments have been made. Pursuant to the mining lease agreement covering
the Al Masane Project, the Company intends to repay the loan in accordance
with a repayment schedule to be agreed upon with the Saudi Arabian
government from its share of cash flows. An Agreement has not yet been
reached regarding either the rescheduling or source of these payments. The
loan is collateralized by all of the Company's "movable and immovable"
assets in Saudi Arabia.
(B) The Refining Segment has a $2.25 million revolving credit facility with the
U.S. office of a multinational bank that is collateralized by a first
security interest in all of its assets. Interest (at the bank's prime rate
plus 1%) is payable monthly. The bank's loan commitment is to be reduced by
at least $105,000 per calendar quarter beginning March 31, 1999. In
addition, the agreement for this credit facility contains various
restrictive covenants including the maintenance of various financial
ratios, net worth and parent company distribution limitations. The credit
facility expires December 31, 2000.
(C) This note was owed to a Saudi Arabian company to is owned by one of the
Company's shareholders and was collateralized by a second security interest
in all of the Refining Segment's assets. The note, which was due in
December 1999, was repaid in December 1998.
(D) Represents loans payable to a shareholder of the Company for $445,000, and
the Company's president for $53,000. $200,000 is due in 1999, with interest
payable at the LIBOR rate plus 2% at maturity. The remaining amounts are
due on demand, with interest payable at the LIBOR rate plus 2%. Each loan
provides for an option to convert the loan amount to shares of the
Company's common stock at $1.00 per
F-14
39
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
share anytime within five years from the date of the loan. In December
1997, a relative of the Company's president and shareholder who had loaned
$300,000 to the Company in 1995, exercised the option and converted his
loan amount, plus accrued interest of $45,000, into common stock.
Scheduled maturities of long-term debt and long-term obligations, which
exclude current notes payable balances aggregating $11,375,780, are as follows:
1999........................................................ $ 498,000
2000........................................................ 1,250,000
----------
Total............................................. $1,748,000
==========
Interest of $418,403, $305,007, $186,190 was paid in 1998, 1997, and 1996,
respectively.
NOTE 9 -- COMMITMENTS AND CONTINGENCIES
The Company's Refining Segment leases various vehicles and equipment from a
related party on a month to month basis at an approximate monthly cost of
$29,000. The Company's total rental costs were approximately $361,000 for each
of the years ended December 31, 1998 and 1997 and $349,000 for the year ended
December 31, 1996.
The Refining Segment has guaranteed a limited partnership's (in which the
Company has a 19% interest) note payable of $160,000.
South Hampton was a defendant in two lawsuits in two district courts in
Jefferson County, Texas brought on July 21, 1993 and July 18, 1994 by two former
employees of the Goodyear Tire & Rubber Company, seeking unspecified actual and
punitive damages for certain alleged illness and diseases resulting from alleged
exposure to certain chemicals during their employment with Goodyear. One of
these lawsuits was settled in March 1997 and the other in January 1998. The cost
to the Company was not significant. A new lawsuit by another former Goodyear
employee was filed in a Jefferson County District Court on December 16, 1997 for
unspecified actual and punitive damages for the same reasons as the other two.
The outcome of this lawsuit is not expected to have a material effect on the
Company's financial position, results of operations or cash flows.
South Hampton has been spending an increased amount of time and expense on
environmental and regulatory functions and compliance. It is South Hampton's
policy to accrue costs associated with regulatory compliance when those costs
are reasonably determinable. Amounts accrued at December 31, 1998 and 1997 were
$250,000 and $110,000, respectively. Amounts charged to expense were
approximately $430,000 in 1998, $220,000 in 1997 and $170,000 in 1996.
In 1993, while remediating a small spill area, the Texas Natural Resources
Conservation Commission ("TNRCC") requested the Company to drill a well to check
for groundwater contamination under the spill area. Based on the results, two
pools of hydrocarbons were discovered in the groundwater. The recovery process
was initiated in June 1998, and is expected to continue for several years until
the pools are reduced to an acceptable level.
In August 1997, the TNRCC notified South Hampton that it had violated
various rules and procedures had proposed administrative penalties totaling
$709,408 and recommended the Company undertake certain actions necessary to
bring its refinery operations into compliance. The violations generally relate
to various air and water quality issues. The Company intends to vigorously
defend against this action since the allegations are in error or involve
relatively minor matters. Modifications have been made where it appeared there
were legitimate concerns. There have been no recent discussions with the TNRCC
regarding this matter.
F-15
40
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- STOCK OPTIONS
The Company's Employee Stock Option Plan (the "Employee Plan") provides for
the grant of incentive options at the market price of the stock on the date of
grant and non-incentive options at a price not less than 85% of the market price
of the stock on the date of grant. The Company has reserved up to 500,000 shares
of common stock for grant pursuant to the Employee Plan. At December 31, 1998,
325,000 shares were reserved for grant. The options vest at such times and in
such amounts as is determined by the Compensation Committee of the Board of
Directors at the date of grant.
The 1987 Non-Employee Director Stock Option Plan (the "Non-Employee
Director Plan") provided for non-employee directors to receive an option for
10,000 shares of common stock upon election to the board of directors with the
exercise price equal to the fair market value of the stock at the date of grant.
The Non-Employee Director Plan expired in 1997.
The Company periodically grants stock options to various parties, including
certain officers and directors, who have made loans to or performed critical
services for the Company. Most of these options allow the parties to purchase
common share for $1.00 per share. In 1996 the Company entered into an agreement,
that was terminated in 1997, with certain advisors who performed various
services for the Al Masane project. The agreement provided the advisors with up
to 2 million shares of the Company's common stock and options to purchase an
additional 2.3 million shares at $1.00 per share. These options were to be
immediately exercisable upon grant and were to have a five year term beginning
with the date the proposed Arabian Mining joint venture was formed. At December
31, 1996, 300,000 shares of common stock (valued at $550,000) and options to
purchase 345,000 restricted common shares (valued at $796,950) had been earned
under this agreement. During 1997, the Company granted options to purchase
100,000 shares of stock and issued 50,000 shares of stock for services to two
directors of the Company and recorded $175,000 of compensation expense.
If the Company recognized compensation expense based upon the fair value at
the grant date for options granted to employees, the Company's net income (loss)
and income (loss) per share would be the pro forma amounts indicated as follows:
1998 1997 1996
---------- -------- ---------
Net income (loss)
As reported...................................... $3,441,646 $818,364 $(390,896)
Pro forma........................................ $3,429,996 $635,714 $(390,896)
Income (loss) per common share -- basic and diluted
As reported...................................... $ 0.16 $ .04 $ (.02)
Pro forma........................................ $ 0.16 $ .03 $ (.02)
The fair value of these options was estimated at the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions; expected volatility of 85 percent; risk-free interest rate of 6
percent; no dividend yield; and expected lives of 3 to 10 years.
F-16
41
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Additional information with respect to all options outstanding at December
31, 1998, and changes for the three years then ended was as follows:
1996
----------------------------
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- ----------------
Outstanding at beginning of year.......................... 1,213,000 $1.15
Granted................................................... 345,000 1.00
--------- -----
Outstanding at end of year................................ 1,558,000 $1.11
========= =====
Options exercisable at December 31, 1996.................. 1,550,000 $1.10
========= =====
Weighted average fair value per share of options granted in 1996 was $2.31.
1997
----------------------------
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- ----------------
Outstanding at beginning of year.......................... 1,558,000 $1.11
Granted................................................... 110,000 1.14
Forfeited................................................. (10,000) 3.50
Exercised................................................. (10,000) 1.38
---------
Outstanding at end of year................................ 1,648,000 $1.10
========= =====
Options exercisable at December 31, 1997.................. 1,639,000 $1.09
========= =====
Weighted average fair value per share of options granted in 1997 was $1.77.
1998
----------------------------
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- ----------------
Outstanding at beginning of year.......................... 1,648,000 $1.10
Forfeited................................................. (10,000) 2.25
Exercised................................................. (58,000) 1.57
---------
Outstanding at end of year................................ 1,580,000 $1.08
========= =====
Options exercisable at December 31, 1998.................. 1,580,000 $1.08
========= =====
Information about stock options outstanding at December 31, 1998 is
summarized as follows:
OPTIONS OUTSTANDING AND EXERCISABLE
---------------------------------------
WEIGHTED AVERAGE
---------------------------
REMAINING EXERCISE
RANGE OF EXERCISE PRICES NUMBER CONTRACTUAL LIFE PRICE
------------------------ --------- ---------------- --------
$0 to $1........................................... 1,443,000 4.8 years $1.00
$1 to $2........................................... 107,000 4.4 years 1.54
$2 to $3.75........................................ 30,000 6.0 years 3.04
---------
1,580,000 $1.08
========= =====
F-17
42
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11 -- INCOME TAXES
The income (loss) before income taxes was $3,697,423, $818,364, and
($390,896) for the years ended December 31, 1998, 1997, and 1996, respectively.
Income tax expense for the years ended December 31, 1998, 1997, and 1996
differs from the amount computed by applying the applicable U.S. corporate
income tax rate of 34% to net income (loss) before income taxes. The reasons for
this difference are as follows:
1998 1997 1996
----------- --------- ---------
Income taxes at U.S. statutory rate.............. $ 1,257,124 $ 278,244 $(132,905)
State taxes...................................... 231,019 -- --
Goodwill amortization............................ 6,461 39,252 94,228
Net operating losses carried forward
(utilized)..................................... (1,255,792) (326,839) 37,924
Other items...................................... 16,965 9,343 753
----------- --------- ---------
Total tax expense...................... $ 255,777 $ -- $ --
=========== ========= =========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities were as
follows:
DECEMBER 31,
-----------------------------------------
1998 1997 1996
----------- ------------ ------------
Deferred tax liabilities:
Refinery plant, pipeline and equipment.... $ (331,263) $ (323,513) $ (287,845)
Deferred tax assets:
Accounts receivable....................... 49,761 45,967 57,284
Mineral interests......................... 196,446 196,446 196,446
Accrued liabilities....................... 93,137 49,341 32,300
Net operating loss and contribution
carryforwards.......................... 9,594,376 10,943,970 11,333,611
Tax credit carryforwards.................. 197,397 147,501 221,322
Deferred gain on sale of property......... 107,853 -- --
----------- ------------ ------------
Gross deferred tax assets................... 10,238,970 11,383,225 11,840,963
Valuation allowance......................... (9,907,707) (11,059,712) (11,553,118)
----------- ------------ ------------
Net deferred tax assets........... 331,263 323,513 287,845
----------- ------------ ------------
Net deferred taxes................ $ -- $ -- $ --
=========== ============ ============
At December 31, 1998 the Company had approximately $28,000,000 of net
operating loss carryforwards and approximately $79,000 of general business
credit carryforwards. These carryforwards expire during the years 1999 through
2011. In addition, the Company has minimum tax credit carryforwards of
approximately $118,000 that may be carried over indefinitely. Approximately
$2,500,000 of the net operating loss carryforwards and $23,000 of the general
business credit carryforwards are limited to the net income of TOCCO.
Approximately $5,900,000 of the net operating loss carryforwards are limited to
the net income of the Coal Company.
The Company has no Saudi Arabian tax liability.
F-18
43
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12 -- SEGMENT INFORMATION
As discussed in Note 1, the Company has two business segments. The Company
measures segment profit or loss as operating income (loss) which represents
income (loss) before interest, miscellaneous income and minority interest.
Information on segments is as follows:
DECEMBER 31, 1998
---------------------------------------
REFINERY MINING TOTAL
----------- ----------- -----------
Revenue from external customers............... $25,089,175 $ -- $25,089,175
Depreciation and amortization................. 428,452 291 428,743
Operating income (loss)....................... 4,160,786 (361,930) 3,798,856
Total assets........................ $ 5,566,887 $38,116,436 $46,683,323
DECEMBER 31, 1997
---------------------------------------
REFINERY MINING TOTAL
----------- ----------- -----------
Revenue from external customers............... $26,174,119 $ -- $26,174,119
Depreciation and amortization................. 537,949 291 538,240
Operating income (loss)....................... 1,277,704 (456,536) 821,168
Total assets........................ $ 7,505,075 $37,547,844 $45,052,919
DECEMBER 31, 1996
---------------------------------------
REFINERY MINING TOTAL
----------- ----------- -----------
Revenue from external customers............... $22,014,286 $ -- $22,014,286
Depreciation and amortization................. 692,960 291 693,251
Operating loss................................ (86,345) (234,779) (321,124)
Total assets........................ $ 7,170,669 $36,925,278 $44,095,947
NOTE 13 -- NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per share has been calculated as follows:
1998 1997 1996
----------- ----------- -----------
Basic
Weighted average shares outstanding......... 21,995,735 21,306,040 20,286,208
Net income (loss)........................... $ 3,441,646 $ 818,364 $ (390,896)
Per Share........................... $ .16 $ .04 $ (.02)
Diluted
Weighted average shares outstanding......... 21,995,735 21,306,040 20,286,208
Dilutive effect of assumed exercise of stock
options.................................. 3,653,960 711,612 --
----------- ----------- -----------
25,649,695 22,017,652 20,286,208
Net income (loss)............................. $ 3,441,646 $ 818,364 $ (390,896)
Per Share........................... $ .14 $ .04 $ (.02)
In 1996, the effect of stock options and convertible debt was
anti-dilutive. Accordingly, loss per share is calculated by dividing the net
loss by the weighted average shares outstanding. In 1997, the effect of assumed
debt conversions is antidilutive.
F-19
44
ARABIAN SHIELD DEVELOPMENT COMPANY AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
THREE YEARS ENDED DECEMBER 31, 1998
CHARGED
BEGINNING (CREDITED) ENDING
DESCRIPTION BALANCE TO EARNINGS DEDUCTIONS BALANCE
----------- ----------- ----------- ----------- -----------
ALLOWANCE FOR DEFERRED TAX ASSET
December 31, 1996...................... $11,803,747 $--(a) $ (250,629) $11,553,118
December 31, 1997...................... 11,553,118 $--(b) (326,839) 11,059,712
(a) (166,567)
December 31, 1998...................... 11,059,712 $--(b) (1,017,340) 9,907,707
(a) (134,665)
- ---------------
(a) Expiration of carryforwards
(b) Utilization of carryforwards
F-20
45
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULES
Board of Directors and Stockholders
Arabian Shield Development Company
In connection with our audit of the consolidated financial statements of
Arabian Shield Development Company and Subsidiaries referred to in our report
dated February 19, 1999, which is included in the annual report to stockholders
in Part IV of this Form 10-K, we have also audited Schedule II at December 31,
1998, 1997, and 1996 and for the years then ended. In our opinion, this schedule
presents fairly, in all material respects, the information required to be set
forth therein.
GRANT THORNTON LLP
Dallas, Texas
February 19, 1999
F-21
46
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10(o) -- Amended and Restated Credit Agreement dated December 28,
1998 between South Hampton Refining Company and Den
norske Bank ASA, together with related Promissory Note.
27 -- Financial Data Schedule